Three Ways to Trade Support and Resistance

By James Stanley, Currency Analyst

21 May 2014 03:00 GMT

Talking Points:

• Support and resistance can have numerous applications and can be identified in a multitude of ways.
• Traders can use support/resistance identification for managing risk in a strategy.
• Traders can also use support and resistance to grade market conditions, and enter positions.

One of the more difficult concepts within Technical Analysis is grasping the premise of support and resistance. There are numerous ways to identify these levels, and even after identified, there are a plethora of ways of integrating and trading with them.

In our first article on the topic, we looked at The Hidden Patterns of Support and Resistance in the Forex Market. We then went on to incorporate additional support and resistance mechanisms in our follow-up article,The Power of Confluence in the Forex Market.

In this article, we’re going to show you three ways that traders can properly integrate these levels.

Risk Management/Stop Placement

While this may be the least ‘exciting’ of the three ways to integrate support and resistance, this is also probably the most important.

Stop-loss orders help traders prevent blowing up their entire accounts on just one or two bad trade ideas. We’ve looked at the importance of stops, and further, risk management in numerous of our previous articles. Sloppy risk management is The Number One Mistake that Forex Traders Make, and this is also the Top Trading Mistake.

Support and resistance can help traders to define their risk amounts for any individual position.

Let’s say that a trader wants to buy in a range, and if that range doesn’t continue, they want to close out the position quickly in an effort to mitigate the loss.

In this case, it makes sense to place the stop for the long position below support so that once support becomes violated, the stop-loss can close the position and the trader can look to avoid taking a larger loss.

Support and resistance can help with stop placement

Created with Marketscope/Trading Station II; prepared by James Stanley

This can also work for reversal plays. If a trader is looking to buy a bullish reversal, they can look to the low that was established before the reversal began; and they can place their stop there. This way, if the reversal doesn’t pan out, and if prices do continue moving in the previous trend-side direction, the position can be closed as traders look to mitigate their loss.

The exact opposite would be the case for short positions, with traders looking to place stops above resistance so that should the market continue rising; the short position can be closed with a minimum of a loss.

Determining a Market’s Condition

We’ve all heard it since we were young: Buy low, and sell high.

If only matters were that simple.

What constitutes ‘high’ and what constitutes ‘low?’ After all, these are very relative matters, and low in a market today might be sky-high a week from now.

This is where support and resistance come into play, and this is why finding strong, confluent levels can be so beneficial.

Think about why support or resistance may come into a market: The only real reason is due to an influx of buyers or sellers at a particular price level.

Let’s say that we’re expecting support at a price of 1.6750 on GBPUSD; which is a psychological level in the currency pair. As prices move lower towards this expected support level, buyers begin coming into the market in anticipation of a future support level being so close. As prices move closer and closer to this level of support, more and more buyers notice this ‘perceived value’ in GBPUSD and they also look to enter in long cable positions. The exact low of the move is considered a ‘price action swing.’

Eventually, the number of buyers in GBPUSD outstrips the number of sellers, and this is what creates a reversal in the market as the higher level of demand takes over smaller level of supply. This is how price action works, and it happens in short and long-terms alike.

Price action will also help traders see support and resistance in trending markets and ranging markets as well. We discussed market conditionality in the article The Life Cycle of Markets.

In trending markets, prices will generally make ‘higher-highs’ and ‘higher-lows,’ or ‘lower-lows’ and ‘lower-highs,’ while ranging markets will generally display more stable levels of support and resistance. The example below in USDJPY shows both of these types of environments on the same chart.

Current price relationship with Support/Resistance can define the market’s condition

Created with Marketscope/Trading Station II; prepared by James Stanley

After the market condition has been identified, traders can then move on to the next step of placing the trade.

Enter Positions

After traders have been able to allocate risk and grade market conditions using price action with support and resistance, they can move on to the next logical step in looking to place trades and enter positions.

Remember that future prices are unpredictable. Implementing support or resistance simply gives us the possibility that support or resistance may hold; and if it does in-fact hold, then traders can look for rewards or profits that are significantly larger than the amount they had to risk. Or put another way, traders can use this as an opportunity to turn around The Top Trading Mistake and get risk management working in their favor by looking for larger rewards using smaller amounts of risk.

If a trader is looking to buy an up-trend, they want to look to do so cheaply. So they can simply wait for prices to retrace a portion of the up-trend until a support level comes in to the market. This support level can be a psychological level, or a Fibonacci retracement, or a pivot point; better yet, this support level can offerconfluence from multiple types of support/resistance analysis.

After price action has exhibited that the retracement may be over, the trader can look to enter long with a stop below the support level. This way, if the up-trend doesn’t continue coming back in the market, the loss can be mitigated. But if the trend does come in, then the trader can look to profit two, three, or four times the amount they had to initially risk entering the position.

We examined how traders can utilize price action to trade trends in the article, Using Price Action to Trade Trends. The image below, taken from the article, shows how traders can look to buy after this ‘higher-low’ was made in the up-trend.

Price action can be used to enter positions in trending markets

Taken from Using Price Action to Trade Trends

But what if the market isn’t displaying a bias?

If the market is ranging, traders can still utilize price action to look at risk-efficient ways of entering trades and positions. We examined this topic in-depth in the article How to Analyze and Trade Ranges with Price Action.

In the image below, we illustrate how traders can use price action along with support and resistance to build a range-strategy in a market devoid of any significant trends:

Price action can also be used to enter trades in ranging markets

Taken from How to Analyze and Trade Ranges with Price Action

--- Written by James Stanley

source : dailyfx.com

Fibonacci As A Leading Indicator

Can You Use Fibonacci As A Leading Indicator?

By Tyler Yell, CMT, Forex Trading Instructor

05 April 2013 03:00 GMT

Article Summary: When studying how to place trades in the direction of the trend many traders focus on the four most common indicators used by technical traders. However, by adding Fibonacci to your trading (Click Here to Register For Our Free Online Fibonacci Course), not only can you locate future targets for stops and exits but you can also find triggers to improve your forex trading results in as little as two steps.

Every trader wants to find high probability set-ups. Naturally, we feel that trading in the direction of the overall trend is the best way to put the odds of success in your favor. Beyond trading in the direction of the dominant trend there are a few tools that you can use to help you find specific entry and exit targets.

What Are Fibonacci Numbers?

In short, Fibonacci numbers or ratios are mathematically significant numbers that occur throughout nature and often in financial markets. They were discovered by Leonardo de Pisa in the 13th century and he was known as the most talented Mathematician in the middle ages. The most important number or ratio is the 61.8% or .618 levels. There is also a 1.618 Extension along with 2.618. In Forex trading, Fibonacci retracements can identify potential support / resistance levels.

Learn Forex: Important Fibonacci Levels Applied to EURUSD to Find Support

(Created using FXCM’s Marketscope 2.0 charts)

From a trading perspective, the most commonly used Fibonacci levels are the 38.2%, 50%, 61.8% and sometimes 23.6% and 76.4%. In a strong trend, which we always want to be trading, a minimum retracement is around 38.2%; while in a weaker trend, the retracements can be 61.8% or even 76.4%. A complete retracement or break of 100% of the prior move would nullify the current move.

How Should I draw The Fibonacci Retracement Trend Line?

The most important thing to know is that the base of the trendline should be drawn from left to right. If there is a bullish trend and you’re currently noticing a retracement to the downside then you’d want to look for support at one of the levels appearing on the chart like we see above on EURUSD. If there is currently a bearish (down) trend and a retracement is taking shape then you’d want to look for resistance.

Learn Forex: Important Fibonacci Levels Applied to GBPUSD (Looking For Resistance)

(Created using FXCM’s Marketscope 2.0 charts)

An important note about using any trading methodology is that neither you nor I can guess with perfect accuracy a future move. So the next best thing is to watch closely levels of support and resistance. Once you notice a strong move off of support in an uptrend or resistance in a downtrend then you can use further levels of resistance as price targets.

Two Methods Of Using Fibonacci To Find Likely Price Targets

The two methods we’ll address in this article with Fibonacci are using the Fibonacci Retracement levels in the direction of the prevailing trend and using either Fibonacci Retracement / Extensions as targets or Fibonacci Expansion Tool. As a refresher, the prevailing trend is the one you’re using to draw the Fibonacci line from. Therefore, in a prevalent downtrend, because you drew from left to right and top to bottom, you are looking for resistance being honored and move back to the downside.

LEARN FOREX: AUDUSD Shows How You Can Use Retracements As Price Targets

(Created using FXCM’s Marketscope 2.0 charts)

Fibonacci Projection Rules

First and foremost, you want to focus on trading in the direction of the trend of the chart you are trading on. The weekly trend may vary from the trend on the 4 hour chart, but if you’re trading on the 4 hour chart than that is the trend you should be focusing on.

Fibonacci Price Extensions

An easy way to think of Fibonacci extensions vs. retracements is that extensions go beyond 100% with the same tool used to find retracement levels. To find an extension level on a new downtrend you would run the low to high extension for possible support. Reversely, on a new uptrend, you would run the high to low extensions for possible resistance that can act as profit targets. The levels most commonly used are the 1.00%, 1.272%, 1.618%, 2.00% or 2.618%.

LEARN FOREX: Fibonacci Extensions Look Beyond the 100% Level For Price Targets – AUDUSD

(Created using FXCM’s Marketscope 2.0 charts)

Fibonacci Expansions or Price Objectives Is Your Third Tool Option

Expansions or Price Objectives are different than Extensions even though they sound similar. The main variation is that you’re now using three key pivots in the market to find your target level. For potential resistance or buy targets, you would draw from a major low to a major high back to a major low to get resistance. For potential support or selling targets you would draw from a major high to major low back to another major high from left to right.

In summary, if you’re using two points alone, you’re using retracements or extensions. If you’re using three points for your target, then you’re using expansion or price objectives. The common levels used for expansions are 0.618, 1.00, and 1.618.

LEARN FOREX: Fibonacci Expansions Looks To Each Level As Next Possible Target – AUDUSD & GBPUSD

(Created using FXCM’s Marketscope 2.0 charts)

(Created using FXCM’s Marketscope 2.0 charts)

Closing Thoughts

Fibonacci Expansions and Extensions can be great leading indicator of price targets once a Retracement level is honored. Deciding which tool to use is a personal choice for price targets as both methods have their benefits. Because this tool is taking you into new price territory, trailing stops are recommended along with the proper trade size so that your risk is always contained.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

source : dailyfx.com

Guidelines for Applying Elliott Wave Theory

A guideline is not a hard and fast rule that can't be broken. It is a tendency - something that happens so often that it can almost qualify as a rule, except for the times it doesn't work as expected. The guidelines described below are useful ways of applying Elliott Wave analysis that have shown their validity over time. But as they are not rules, they may not work out every time.

Guideline 1

The Guideline of Equality says that two of the motive sub-waves in a five wave sequence will tend toward equality, and is generally true of the non-extended waves.

This means that when Wave 3 of an impulse wave is the extended wave, Wave 5 will approximately equal Wave 1 in price. This is useful for potentially projecting the end of Wave 5 in an impulse if you recognize Wave 3 as an extended wave.

Guideline 2

The Guideline of Alternation within an Impulse says that the forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp style of correction, Wave 4 will be a sideways style of correction. If Wave 2 is sideways, Wave 4 will be sharp. This is useful for anticipating the end of a Wave 4 correction within a suspected impulse.

Guideline 3:

The Guideline of Alternation within a Correction says that the forms for Wave A and Wave B will alternate within a 3 wave correction. If Wave A is a flat type of correction, Wave B may be a zigzag type of correction and vice versa. It also states that if the correction begins with a more simple wave for Wave A, expect the following Waves B and C to be more complex.

Guideline 4:

The Guideline of Depth of Corrective Waves says that when the market goes into a correction, it often will correct to the territory of the previous Wave 4 of lesser degree. This does not necessarily mean that it will reach the bottom of the previous 4th wave, but rather that we should expect it will reach the span of the previous Wave 4 of lesser degree. This is often a good place for a market to find support (or resistance) before the trend moves on.

Guideline 5:

The Guideline of Channeling is really a technique to project the potential end of waves within impulses. Although channeling can be used for corrective waves, it really boils down to the application of trend lines and doesn't have any hard tendencies for corrective applications. As for impulse waves, Elliott noticed that channel lines often mark their boundaries with sometimes dramatic precision.

There are three ways that channeling can be used for projecting the end of waves, but they all use the same technique. They both require three points - beginning and ending of waves - to create their channels, one technique for projecting the end of Wave 3, one technique for projecting the end of Wave 4, and one technique for projecting the end of Wave 5.

Projecting the end of Wave 3: Draw a trend line from the beginning of Wave 1 to the end of Wave 2. Project a parallel line off the end of Wave 1. There is a potential for Wave 3 to end when it reaches the projected trend line.

Projecting the end of Wave 4: Draw a trend line from the beginning of Wave 2 to the end of Wave 3. Project a parallel line off the end of Wave 2. There is a potential for the Wave 4 correction to end when it reaches the projected trend line.

Projecting the end of Wave 5: Draw a trend line from the beginning of Wave 3 to the end of Wave 4. Project a parallel line off the end of Wave 3. There is a potential for Wave 5 to end when it reaches the projected trend line.

Guideline 6:

The Guideline of Scale is really a technique of looking at the market and is often applied when creating channel projections. It simply states that one should use both an arithmetic scale chart and a semi-log scale chart when looking at Elliott Waves. Arithmetic scale charts are good for looking at waves on lower degrees, but semi-log scale charts are good for bringing large trends (higher degrees) into perspective. A channel may work nicely on a semi-log scale, whereas on an arithmetic scale it may not.

The Personality of Elliott Waves

Wave “personality” is the reflection of mass psychology acting in the market - the emotions that flow from optimism to pessimism, creating the structures we see in the market. The personality of each wave type is the same whether it is a higher degree wave or a lesser one. This section will expand on the characteristics of some of the waves. Please keep in mind the eight wave cycle when going over this section.

First Waves (Wave 1):

About half of the first waves seen are part of the basing process and tend to be heavily corrected by Wave 2. Many people feel that this is one more opportunity to trade in the direction of the previous trend, and, if that was down, many will sell short. However, market breadth and volume will subtly increase.

The other 50% of first waves will rise from large basing price movement formed by the previous correction and these tend to be dynamic and only moderately retraced. This is a good probable spot to have a Wave 1 extension.

Second Waves (Wave 2):

Second waves tend to retrace so much of Wave 1 that most of the profits gained are eroded. They tend to end on low volume and low volatility. In a bear market this indicates a drying up of selling pressure. However, during Wave 2 most investors are convinced that the bear market is here to stay.

Third Waves (Wave 3):

Third waves tend to be strong and broad. They are typically unmistakable, as confidence in the direction of the new trend is clearly evident. Wave 3 usually generates the most volume and price movement, and they are the most likely wave to extend. The third wave of an extended third wave will likely be the most volatile point of strength in the new trend and things like price breakouts, continuation gaps, volume expansions, and increased breadth will accompany it. In a third wave in a stock index, nearly all stocks will participate. Because of the dynamics of this wave, it will provide the greatest clues to the correct wave count as it unfolds.

Fourth Waves (Wave 4):

Fourth waves can be predictable in both depth and form because of the guideline of alternation. They tend to differ with the previous Wave 2 of the same degree. They often trend sideways building a base for the final Wave 5 to spring from. In a fourth wave in a stock index, lagging stocks will tend to build their tops and start declining.

Fifth Waves (Wave 5):

Fifth waves tend to be less dynamic and display slower speed of price change than the previous waves. It will usually be accompanied by lesser volume and breadth.

Of course, if the fifth wave is the extended wave, this will not be the case in terms of price change. In advancing fifth waves, optimism is extremely high despite a narrowing of breadth. However, the fifth wave of an extended fifth will lack the change of the previous waves and give clues about a change in direction.

A Waves (Wave A):

During Wave A, the public is convinced that this is just a correction of the previous trend and will rush in to capitalize on it, despite any technically damaging signals. This sets things up for the next wave to follow. If Wave A is divided into five sub-waves, it will be a zigzag. If it is divided into three sub-waves, it will be a flat, or a triangle.

B Waves (Wave B):

Wave B catches people in the wrong direction. It performs the task of enticing the suckers to jump into the market. This is where bear or bull traps happen. As a general rule, B Waves tend to show lower volume.

C Waves (Wave C):

Wave C tends to break the illusions of Wave A and Wave B. In a declining market, it can be devastating and fear takes over with broad participation. An advancing Wave C as an upward correction in a larger bear market can be just as dynamic and it fools investors into thinking that it is the start of a new upswing. The fact that Wave C may do this in five sub-waves helps the deception.

D Waves (Wave D):

Wave D shows up in horizontal triangles. If the triangle is contracting, it often is accompanied by an increase of volume. This is because it does not fully retrace the previous wave and is moving in the direction that the market is about to take after the following Wave E.

E Waves (Wave E):

Wave E shows up as the last wave in horizontal triangles. It will often stage a false break of the trend line on the boundary of the triangle before the market takes off in the opposite direction. If the triangle was a Wave 4 in a rising impulse, it would instill a bearish conviction before the market shot up to produce Wave 5. Thus Wave E is often attended with emotional psychology playing against the investor.

Conclusion

These three articles have gone over the rules of Elliott Wave Theory in some detail. However, as stated before, putting Elliott Wave to use will take some practice. Nevertheless, if you persist in applying the rules, eliminating non-conforming counts, and looking at the personality of the waves you are counting, you will find satisfaction in applying the Elliott Wave theory. You will prove to yourself that the market indeed does conform to these patterns and that there is meaning behind them.

You will often find that it is necessary to adjust the count you made to conform to new data. Don't get frustrated by having to make adjustments – it paves the way to a more accurate wave-count and helps to refine your skills. This is something that is expected in doing Elliott Wave analysis as the skills in applying it come through practice.

Not every nuance of Elliott Wave Theory has been discussed here. There are many books written on the subject. Here are a few book recommendations that are considered by many to be excellent resources in helping one to apply Elliott Wave: The Elliott Wave Principle by Frost and Prechter - this is considered to be the main primer for the theory; Mastering Elliott Wave Principle by Constance Brown - this book offers excellent techniques in recognizing the waves; and Visual Guide to Elliott Wave Trading by Wayne Gorman and Jeffrey Kennedy - this book offers good advice in how Elliott Wave can be used in trading.

One subject that is not discussed is the use of Fibonacci counts and ratios that are applied to Elliott Waves. This is a broad and important subject, but it is not only applied to Elliott Waves, and it is too large to cover here. The books mentioned above will go into some detail on how this subject can help when applying Elliott Wave. It is a worthwhile study.

Adding Elliott Wave Notation to SharpCharts

The Elliott Wave Tool which is part of the ChartNotes annotation tool can be used to add wave counts to any SharpChart. This tool is marked with the Roman numeral I set in double parens at the top of the Chartnotes page, which appears when annotating a SharpChart. Click on the icon to see the wave degree options. Click one of the options to select a particular degree. Once selected, chartists can then move to Wave 1 and click to mark this wave. Move to Wave 2 and click to mark. This click-mark action will last as long as you keep clicking. Once the waves are marked on the chart, users can use the “selection tool” to move current marking about the chart or click-delete to remove. The “selection tool” is the pointer the upper left corner of the annotation window.

source : stockcharts.com

Elliott Wave Basics

Introduction

Elliott Wave Theory was developed by R.N. Elliott and popularized by Robert Prechter. This theory asserts that crowd behavior ebbs and flows in clear trends. Based on this ebb and flow, Elliott identified a certain structure to price movements in the financial markets. The article serves as a basic introduction to Elliott Wave Theory. A basic 5-wave impulse sequence and 3-wave corrective sequence are explained. While Elliott Wave Theory gets much more complicated than this 5-3 combination, this article will only focus on the very basics.

Wave Degrees

The labeling convention shown above is a hybrid between that shown in the Elliott Wave book and the Elliott tools from SharpCharts. In Elliott-speak, this labeling convention is used to identify the degree or level of the wave, which represents the size of the underlying trend. The upper case Roman numerals represent the large degree waves, the simple numbers represent the medium degree waves and the small-case Roman numerals represent the small degree waves. The trends start with the largest degree (Grand Supercycle) and work their way down to waves of lesser degree. For example, the Cycle wave is one larger degree than the Primary wave. Conversely, the Primary wave is one lesser degree than the Cycle wave. Wave 1 of (1) would indicate that Wave 1 is part of a larger degree Wave (1). Wave 1 is a lesser degree than Wave (1).

In reality, most chartists will only use 1 to 3 wave degrees on their charts. It can get quite complicated trying to apply nine Wave degrees or even just using the labeling convention in the order provided. Chartists using 1 to 3 wave degrees can simply label the highest degree waves with upper case Roman numerals (I,II,III,IV,V,a,b,c), the middle degree waves with numbers (1,2,3,4,5,A,B,C) and the lowest degree waves with lower case Roman numerals (i,ii,iii,iv,v,a.b,c). This provides three distinct groups for labeling various waves.

Basic Sequence

There are two types of waves: impulse and corrective. Impulse waves move in the direction of the larger degree wave. When the larger degree wave is up, advancing waves are impulsive and declining waves are corrective. When the larger degree wave is down, impulse waves are down and corrective waves are up. Impulse waves, also called motive waves, move with the bigger trend or larger degree wave. Corrective waves move against the larger degree wave.

The chart above shows a rising 5-wave sequence. The entire wave is up as it moves from the lower left to the upper right of the chart. Waves 1,3 and 5 are impulse waves because they move with the trend. Waves 2 and 4 are corrective waves because they move against this bigger trend. A basic impulse advance forms a 5-wave sequence.

A basic corrective wave forms with three waves, typically a, b and c. The chart below shows an abc corrective sequence. Notice that waves a and c are impulse waves (green). This is because they are in the direction of the larger degree wave. This entire move is clearly down, which represents the larger degree wave. Waves a and c move with the larger degree wave and are therefore impulse waves. Wave b, on the other hand, moves against the larger degree wave and is a corrective wave (red).

Combining a basic 5 wave impulse sequence with a basic 3 wave corrective sequence yields a complete Elliott Wave sequence, which is a total of 8 waves. According to Elliott, this complete sequence is divided into two distinct phases: the impulse phase and the corrective phase. The abc corrective phase represents a correction of the larger impulse phase.

These 8-wave charts show two larger degree waves (I and II) as well as the lesser degree waves within these larger degree waves. Waves 1-2-3-4-5 are one lesser degree than Wave I. By extension, Wave I is one larger degree than Waves 1-2-3-4-5. Waves a-b-c are one lesser degree than Wave II.

Fractal Nature

Elliott Wave is fractal. This means that wave structure for the GrandSuper Cycle is the same as for the minuette. No matter how big or small the wave degree, impulse waves take on a 5-wave sequence and corrective waves take on a 3-wave sequence. Any impulse wave subdivides into 5 smaller waves. Any corrective wave subdivides into three smaller waves. The charts below show the fractal nature of Elliott Wave in action.

Three Rules

Believe it or not, there are only three rules when it comes to interpreting Elliott Wave. There are many guidelines, but only three HARD rules. These are unbreakable. Guidelines, on the other hand, are bendable and subject to interpretation. Furthermore, these rules only apply to a 5-wave impulse sequence. Correction, which are much more complicated, are given more leeway when it comes to interpretation.

Rule 1: Wave 2 cannot retrace more than 100% of Wave 1.

Rule 2: Wave 3 can never be the shortest of the three impulse waves.

Rule 3: Wave 4 can never overlap Wave 1.

Wave 2 cannot move below the low of Wave 1. A break below this low would call for a re-count. Even though Wave 3 is typically the longest of the three impulse waves, there is a specific rule that it cannot be the shortest. 1 or 5 can be longer than Wave 3, but both cannot be longer than Wave 3. It is probably best to use percentages or log scales when measuring Wave length. Elliott Wave indicates that Wave 3 must exceed the high of Wave 1. Failure to exceed this high would call for a re-count. Impulse moves are all about making progress. Failure to exceed the high of Wave 2 would not be making progress. The third, and final rule, is that Wave 4 cannot overlap Wave 1, which means the low of Wave 4 cannot exceed the high of Wave 1. Such a violation would call for a re-count.

Three Guidelines

There are numerous guidelines, but this article will focus on three key guidelines. In contrast to rules, guidelines should hold true most of the time, not necessarily all of the time.

Guideline 1: When Wave 3 is the longest impulse wave, Wave 5 will approximately equal Wave 1.

Guideline 2: The forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp correction, Wave 4 will be a flat correction. If Wave 2 is flat, Wave 4 will be sharp.

Guideline 3: After a 5-wave impulse advance, corrections (abc) usually end in the area of prior Wave 4 low.

The first guideline is useful for targeting the end of Wave 5. Even though Wave 5 could be longer than Wave 3 and Wave 3 could still be longer than Wave 1, chartists can make initial Wave 5 projections once Wave 4 ends. In a larger uptrend, chartists simply apply the length of Wave 1 (percentage change) to the low of Wave 4 for an upside target. The opposite is true for a 5-wave decline. The percentage decline in Wave 1 would be applied to the high of Wave 4 for a Wave 5 estimate.

The guideline of alternation (2) is useful for determining the time of correction for Wave 4. After a sharp decline for Wave 2, chartists can expect a relatively flat correction for Wave 4. If Wave 2 is relatively flat, then chartists can expect a relatively sharp Wave 4. In practice, Wave 2 tends to be a rather sharp wave that retraces a large portion of Wave 1. Wave 4 comes after an extended Wave 3. This Wave 4 marks more of a consolidation that lays the groundwork for a Wave 5 trend resumption.

The third guideline is useful for estimating the end of a Wave II correction after a Wave I advance. Waves I and II are the larger degree waves. Waves 1-2-3-4-5 are lesser degree waves within Wave I. Once the Wave II correction unfolds, chartists can estimate its end by looking at the end of the prior wave 4 (lesser degree wave 4). In a larger degree uptrend, Wave II would be expected to bottom near the low of lesser degree Wave 4. In a larger degree downtrend, Wave II would be expected to peak near the high of lesser degree Wave 4.

Conclusions

Even though this article just scratches the surface of Elliott Wave Theory, chartists can greatly improve their counting by applying the three rules and three guidelines listed. Elliott Wave counts start with a process of elimination. Apply the rules for the first count attempt and then the guidelines on the second. Eliminating bogus counts paves the way to a more accurate count. Even with accurate counts, chartists will still need to re-evaluate and adjust counts as new price information emerges. It is just the nature of the beast.

SharpCharts

The Elliott Wave Tool on SharpCharts can be used to make wave counts. This tool is marked with the Roman numeral I set in double parens at the top of the Chartnotes page, which appears when annotating a SharpChart. Click on the icon to see the wave degree options. Click one of the options to select a particular degree. Once selected, chartists can then move to Wave 1 and click to mark this wave. Move to Wave 2 and click to mark. This click-mark action will last as long as you keep clicking. Once the waves are marked on the chart, users can use the “selection tool” to move current marking about the chart or click-delete to remove. The “selection tool” is the pointer the upper left corner of the annotation window.

source : stockcharts.com