Lets go on with Elliot wave theory and talk about the guidlines of the wave framework.
Guidelines for the wave framework
While there’s just 3 rules in the wave theory, there are a number of guidelines than in theory should make our lives a lot more easier, but in practice make it all more confusing. But in order to work with wave theory right, we also need to be aware of those.
Relationships between waves that reflect the aspect of Fibonacci ratios are just tendencies, not permanent relationships. The relationships CAN and DO change. If you see a tendency on the chart, take it as a tendency until you can actually see an evidence that this tendency is currently working. Cyclical changes in the market change those tendencies.
Guidelines: Time
There’s no time constraints on market patterns. When considering the length of waves, impulse waves are more closely related to other impulse waves and corrective waves are more related to other corrective waves. In any wave sequence (5 wave sequence), only 30-35% of the time is spent to create the impulse waves.
Guidelines: Impluse waves
First wave is not that important until 3rd wave or potential 3rd wave is seen. It is difficult to predict the ending of the 3rd wave. Even though 3rd wave can be shorter than 1st wave it is often not. If it is not shorter it may be equal to first wave or 1.618 times the first wave. In case of extensions it can be also 2.618 or 4.618 times the first wave. Third wave is usually steeper than the first wave, sometimes straight up or down. Third waves have usually bigger volume than 1st wave and also stronger momentum.
The length of the 5th wave could be the fibonacci ratio of the price from the origin of first wave to the end of the 3rd wave. The typical relationship – Wave 5 is 0.382 or 0.618 times as long as the distance between Wave 1-the end of Wave 3. Often, Wave 5 is also as long as 1.618 times Wave 1. These rules assume that wave 1 and 3 are not extended.
Guidelines: Extensions
In any 5 wave sequence, only expect 1 impulse wave to be extended. If 3rd wave is extended, then waves 1 and 3 are often equal in whether time or price movements. If there’s extension on 3rd wave, then often the middle of the 3rd wave’s 3rd wave is the middle point of the main 3rd wave. Extensions (in foreign exchange market) appear on 1st wave only 5% of the time compared to 60% in case of 3rd wave. If the second wave retraces less than 50% of the first wave, there’s a good chance that 3rd wave WILL be extended one. Correction waves in extensions are usually smaller, usually the retracement is 23.6% from the previous wave.
Guidelines: Alternation
If Wave 2 has retraced 61.8% or more of Wave 1 then Wave 4 is very likely to retrace 38.2% or less of Wave 3. At the same time, if Wave 2 retraced only 38.2% then Wave 4 would retrace usually 23.6% or 50%.
Guidelines: Corrective waves
Corrective waves are often 0.236, 0.382, 0.5 or 0.618 times the length of the preceeding impulse wave. Wave 2 usually retraces more than Wave 4, often 61.8% or more of the Wave 1. Most likely retracement for Wave 4 is 38.2% of Wave 3.
Guidelines: horizontal triangles
If you can see a horizontal triangle then this is considered one of the most reliable forms in Elliot wave principle that the trend is going to continue.
Note that there is actually more guidelines in Elliot Wave theory, but I will not go into them, letting you discover things by yourself as well.
Elliot Wave theory is sort of flexible and you shouldn’t be unable to consume new facts. If you were sure something is likely to happen, it probably isn’t and you should see new facts you have no got and base your decisions on the new facts instead of the old ones.
