Forex Elliott Wave Trading Strategy: Ultimate Guide

Forex Elliott Wave Trading Strategy: Ultimate Guide

Elliott Wave theory is a powerful technical analysis tool utilized for several years to predict price movements on the financial markets. It is widely employed by well-off traders in the forex market to gain essential insights into the direction and intensity of currency pairs, and to make well-informed trading decisions. Are you curious about the methods successful traders use to forecast market movements and trade profitably? If so, Elliott Wave analysis is essential to learn about! 

What is Elliott Wave Theory? 

Elliott Wave theory is essentially based on the idea that market prices move in a predictable pattern of five waves in the direction of the main trend, followed by three waves of corrective movement. Economic developments, geopolitical shifts, and investor sentiment are just a few of the variables that affect these waves. By noticing this trend, traders may be able to control their risks, pinpoint the best times to join or exit the market, and hone their trading tactics. 

The fundamentals of the Elliott Wave Forex Theory are actually quite simple. In the early 1920s, Ralph Nelson Elliott discovered that the stock markets did not operate in an unpredictable manner, but rather followed repetitive cycles. He showed that the cycles were closely linked to the prevailing psychology of the masses and their responses to external factors. Elliott then identified consistent patterns in the way mass psychology drove market movements, which he termed ‘waves.’  

Drawing from the Dow Theory, which asserts that stock prices move in waves, Elliott’s analysis of the fractal nature of these waves allowed for a more comprehensive interpretation of the market. 

How does Elliott Wave Theory Works? 

According to Elliott, every action is inevitably accompanied by a reaction. This means that any sudden or impulsive move will eventually be balanced out by a corrective one. 

How to Start a Successful Trading Career
  • In terms of wave analysis, the first five waves of a trend represent the impulsive move, which moves in the direction of the main trend. Following these five waves, the subsequent three waves represent the corrective phase. Overall, this creates a 5-3 move pattern consisting of one five-wave impulsive move and a three-wave corrective move labeled A, B, and C. 
  • Once this 5-3 move is complete, a full cycle occurs. However, this 5-3 pattern can also be seen as part of a larger 5-3 wave. Within the impulsive wave, the individual waves are numbered 1-5, while the corrective waves are designated A, B, and C. 
  • By analyzing the moves individually, it can be observed that the first impulsive move is composed of 5 waves, with 3 waves following the trend and 2 waves against it. On the other hand, the corrective move consists of 3 waves, with 2 waves against the trend and 1 wave along the trend. 

What is intriguing is that the corrective wave’s three legs can have implications on how highs and lows are used to perceive trends more broadly. According to Elliott Wave theory, while the formation of higher highs and higher lows typically indicates an uptrend, the occurrence of a lower high and lower low can often be seen as a short-term correction to that trend. This does not necessarily invalidate the trend, but rather signifies a period of retracement that is more forceful than the previous corrections observed within the impulsive move. 

Here’s a detailed guide on how to read chart patterns in forex trading!

Cycles and Waves 

Elliott’s theory emphasizes the psychological aspect of trading, which often generates waves instead of straight lines. This phenomenon is one of the theory’s significant features and stems from Elliott’s examination of Charles Dow’s work, which proposed that stock prices move in waves according to Dow Theory. Elliott also incorporates cycles, which contribute to the patterns’ restorative nature.  

The theory primarily focuses on waves as the primary form observed in markets, and the fractal nature of the waves reveals that similar patterns occur on both short and long-term charts. Based on his repeated observation of these patterns, Elliott proposed that they could be a useful tool for predicting future price movements. 

What is a fractal pattern? 
A fractal is a pattern that repeats itself endlessly, maintaining its similarity across various scales. Elliott discovered these fractal patterns, also known as waves, in the financial market and devised a method for predicting their behavior. Although Elliott's Wave Theory is now widely accepted, during his time, the scientific community failed to recognize his theory due to the evidence and principles he used, which were not acknowledged as scientific by his contemporaries. 

Using Elliott Wave Patterns to Predict the Market 

Elliott used reliable characteristics found in wave patterns to make detailed predictions about the financial market. He observed that impulse waves, which move in the same direction as the larger trend, always exhibit a five-wave pattern. Conversely, corrective waves move in the opposite direction of the main trend. Within each impulsive wave, five waves can again be found at a smaller scale, creating a repeating fractal structure.  

Elliott first discovered this fractal pattern in financial markets in the 1930s, although it took several decades for scientists to recognize and demonstrate it mathematically. In financial markets, price movements always have a contrary movement following them, and are divided into trends and corrections. Trends indicate the main direction of prices, while corrections move in the opposite direction of the trend. 

Wave Degrees: 

A series of categories have been assigned by Elliott to the waves, highlighting that similar patterns can be observed in both short-term and long-term charts. The categories are as follows: 

  • Grand Supercycle: lasting for several centuries 
  • Supercycle: lasting for several decades (roughly 40 to 70 years). 
  • Cycle: ranging from one year to multiple years (can extend to several decades in the case of an Elliott Extension) 
  • Primary: lasting for a few months to a couple of years 
  • Intermediate: ranging from weeks to months 
  • Minor: lasting for weeks 
  • Minute: lasting for days 
  • Minuette: lasting for hours 
  • Sub-minuette: lasting for minutes 
What is the golden ratio in Elliot waves? 
The Golden Ratio, also known as Phi (φ), is crucial in Elliott Wave Theory, an approach to predicting financial market trends. In five-wave impulse patterns and three-wave corrective patterns, the ratio 1.618 is used to pinpoint potential price targets. A retracement of corrective waves commonly occurs at 38.2%, 50%, or 61.8% of the preceding wave, which is the ratio between Wave 3 and Wave 1. 

The Elliott Wave Forex Theory by Example 

It’s important to acknowledge and comprehend the principle that every action in a financial market, particularly price movements, has an equal and opposite reaction. For instance, if the price of gold goes up, more people may start selling gold, while if the price drops, more people may start buying gold. 

Elliott observed this principle through trends (also called impulsive waves) and corrections (also called corrective waves). Trends represent the primary direction of prices, while corrections work against the trend to balance it out. 

Each action and reaction have a specific place in the fractal pattern, which Elliott used to classify waves and demonstrate their repetitive nature. Therefore, this principle of balancing and counterbalancing is crucial to understanding the functioning of financial markets. 

How to Apply Elliott Wave Theory in Forex Trading? 

The realm of Forex trading is known for being intricate, but it also presents opportunities for significant financial gains. As the global economy becomes increasingly interconnected, it is crucial for business proprietors and market analysts to establish, analyze, and comprehend the correlations between various currencies. 

Forex Elliott Wave Trading Strategy: Ultimate Guide

The Elliott Wave Forex Theory in practice 

According to Elliott Wave Theory, the movement of prices follows a specific pattern consisting of five waves.  

  • In an upward trend, the five waves represent a rise, while the subsequent three waves represent a fall.  
  • Conversely, in a downward trend, the five waves represent a fall, while the subsequent three waves represent a rise.  
  • These five waves are known as “impulse waves,” while the three waves are called the “corrective waves.” 
  • During the first phase of the uptrend, also known as the “impulsive wave,” prices rise and investors anticipate a change in the trend. This creates a negative outlook for prices.  
  • During the second wave, prices do not decrease significantly, while in the third wave, prices rise, bringing positive news to the market.  
  • In the fourth wave, prices decline due to profit-taking, leading to an optimistic outlook among investors, who receive positively inclined market news. 
Is Elliot Wave a good strategy? 
Experienced traders use Elliott Wave research to spot market trends and future price changes. It is a common technique among some traders for locating entry and exit positions and foreseeing market moves, while not being widely used. Elliott Wave analysis is not without its detractors, and some traders favour using a mix of other technical analysis tools. 

Best Indicators For Forex Elliott Wave Trading Strategy 

Here are some of the best indicators that can be used in Elliott Wave trading strategy: 

1. Elliott wave and Fibonacci Retracement Strategy 

The Elliott wave and Fibonacci retracement strategy is a popular approach used to analyze financial markets, including forex. Elliott wave theory suggests market movements follow a pattern of five impulsive waves (motive waves) and three corrective waves. Fibonacci retracement levels, derived from the Fibonacci sequence, identify potential support and resistance levels. Here are the steps. 

  • Identify trend direction using Elliott wave analysis 
  • Draw Fibonacci retracement levels 
  • Look for potential entry/exit points at Fibonacci levels corresponding to previous support/resistance 
  • Confirm using Elliott wave analysis 
  • Set stop loss/take profit levels based on Fibonacci levels. 

This strategy can be complex, and a solid understanding is crucial before using it in live trading. 

2. Elliott Wave and RSI Indicator 

Elliott Wave traders frequently look for divergences between the RSI indicator and the price data. When the price chart and RSI travel in opposing directions, this happens, and it can signal a potential trend reversal.  

For instance, if the RSI shows lower highs during a bullish pattern, when the price chart shows higher highs and higher lows, a bearish divergence may be present. This suggests that the bullish tendency might be waning.  

Similar to this, a bullish divergence could be seen if a negative trend with lower lows and lower highs is present, but the RSI shows higher lows, indicating that the bearish trend may be losing steam. 

3. Elliott Wave with MACD Indicator  

Making better trading choices can be aided by combining the Moving Average Convergence Divergence (MACD) indicator and Elliott Wave theory to increase the precision of market analysis. 

Traders can use the MACD in Elliott Wave analysis to confirm the wave count and identify potential turning points. Traders can check the MACD for any divergences between the indicator and price movement after setting a wave count. A bullish divergence and possible bullish reversal are indicated when the price is making lower lows while the MACD is making higher lows. A bearish divergence and possible bearish reversal are indicated when the price is making higher highs while the MACD is making lower highs. 

Additionally, traders can use the MACD to determine when an Elliott Wave period has finished. The MACD histogram could signal the end of one wave cycle and the start of another if it hits a peak or trough and then reverses direction. To confirm the trend’s direction and identify possible entry and exit positions, traders can also look for MACD crossovers. 

4. Elliott Wave with Bollinger Bands Indicator 

Bollinger Bands are a popular tool used to measure market volatility in technical analysis. They consist of three lines, with a simple moving average (SMA) in the middle and two standard deviation lines above and below the SMA. In Elliott Wave analysis, Bollinger Bands can be used to identify potential breakouts and trend reversals by following these steps: 

  1. Identify the Elliott Wave pattern in the market. 
  1. Look for converging Bollinger Bands, which suggest the market is becoming less volatile, and a breakout may be imminent. 
  1. Wait for a breakout to occur, indicated by a price breaking above or below the upper or lower Bollinger Band, respectively. 
  1. Confirm the trend using other technical indicators, such as the MACD or RSI, to determine if the trend is likely to continue. 

However, it’s important to note that no single indicator is 100% accurate, and it’s always best to use a combination of different indicators and techniques to analyze the market. 

How Elliott Wave Theory Can Be Used to Make Profits in Forex? 

Understanding and using the Elliott Wave Theory analysis is essential for Forex traders who want to maximize their profits. Based on the psychological variables of brokers and trading players, this strategy aids in identifying the market trend direction and the rise and fall of currency prices. 

Even while mastering the technical aspects of Elliott Wave Forex Theory may require some time and careful study, it can be a useful tool to improve your trading approach. It should not be utilized as the sole metric for entry and exit points, but rather as a supplementary measurement. 

Trading can be made more accurate by combining the EW oscillator with additional indicators like MACD and RSI. Although the regulations for trading forex are identical to those for stocks, shorting trading assets in forex provides higher gains from the oscillator. Elliott Wave analysis has advantages and disadvantages, but the trick is to make the most of its advantages to increase trading profitability. 

What is the best timeframe to use Elliott Wave? 
Many people use the Elliott Wave theory to identify market patterns and turning points. The recommended timeframe that traders and investors use depend on their trading style. Shorter timescales, like 15-minute or hourly charts, present more frequent trading possibilities, whilst longer timeframes, such as daily or weekly charts, have a wider perspective. 

What is the accuracy of the Elliott Wave Forex Theory? 

Elliott’s waves, a trading theory, generate strong opinions within the trading community. While some traders rely on this oscillator for analysis, others reject it entirely. It should be noted that this theory remains unproven, and any decision to use EW trading recommendations should be made at the trader’s own risk. 

Despite this uncertainty, the EW oscillator is a popular tool among traders and has given rise to a unique form of analysis known as EW analysis. To determine whether this tool is a valuable addition to a trader’s strategy, it is recommended to practice extensively using virtual funds on a demo account. 

While comprehending the waves may be challenging initially, continued practice will eventually lead to mastery. As traders combine the EW oscillator with their existing trading setup, they can determine if it suits their style and can potentially offer benefits. 

Learning is helpful, but practicing is everything! 

No matter how much information and expertise you are able to gather about the market, but without putting it into practice, it is worth less. Gaining complete market exposure improves your trading skills by teaching you patience and focus. Forex demo account let you try various trading strategies with fictitious funds without using real money, enabling you to determine the trustworthiness of the Forex broker. 

forex demo account

While forex demo accounts let novice traders practice the market without taking any risks, relying on them for extended stretches of time has no financial benefit. Trading on a real account is the only method to engage in forex trading and achieve significant profits. 

Forex Elliott Wave Trading Strategy: FAQ 

What is the Elliott Wave concept? 

Elliott observed a pattern where a trend is usually accompanied by an impulsive wave, followed by a counter-trend reversal wave. He noted that such an impulsive wave is typically composed of five waves, followed by a three-wave corrective phase. A fractal pattern can be observed in smaller and larger timeframes because we can perceive the initial five waves as a single impulse. 

Do professional traders use Elliott Wave? 

Yes, professional traders use Elliott Wave analysis to identify market trends and future price changes. It is a common technique among some traders for locating entry and exit positions and foreseeing market moves, while not being widely used. Elliott Wave analysis is not without its detractors, and some traders favor using a mix of other technical analysis tools. 

What is Elliot wave strategy in Forex? 

Elliot Wave theory is a Forex tool used to identify trends and potential reversal points. It suggests that Forex price movements occur in five-wave “impulses” in the trend direction and three-wave “corrections” against it. Traders use it to find entry and exit points, usually with additional technical analysis tools. 

Does Elliott Wave always work? 

No, Elliott Wave Theory does not always work. Although it is popular among traders, this method of forecasting is not foolproof. A series of waves can be divided into Elliott Wave patterns to explain the movement of financial markets. Investor sentiment, economic policies, and unexpected news can influence the market. 

What is the success rate of Elliott Wave? 

According to studies, there is a 50% success rate, which is not much better than chance. However, the success rate of the Elliott Wave Theory depends on a number of variables, including analyst skill, reliable market data, and pattern interpretation. While proponents claim it is highly accurate at foretelling market moves, detractors say it is subjective, open to interpretation, and unreliable. 

Which indicator works best with Elliott Wave? 

Elliott Wave analysis uses moving averages, RSI, Fibonacci retracements, MACD, and Bollinger Bands. These can be used to spot trends, support and resistance levels, overbought or oversold situations, shifts in trend momentum, possible support and resistance levels, and trend reversals or volatility changes. 

Which Elliott Wave is the strongest? 

The Elliott Wave Theory analyzes financial markets by identifying repeating patterns in two main types of waves: impulse waves (larger, more powerful waves that move with the trend) and corrective waves (smaller waves that move against the trend). Impulse waves contain five smaller waves labeled 1-5, with wave 3 being the strongest and longest. It can even be larger than waves 1 and 5 combined. 

How accurate is the Elliott Wave Cycle? 

Debate surrounds the accuracy of the Elliott Wave Cycle among traders and analysts. Proponents claim that the patterns, based on human psychology, can predict future market movements, while critics argue that the theory is subjective and challenging to apply in real-world trading situations. 

What are the disadvantages of Elliott Wave? 

Although applying the Elliott Wave theory can be beneficial for traders and investors, there are a number of disadvantages. The subjective interpretation, intricacy, time commitment, limited predictability, over-analysis risk, and confirmation bias of Elliott Wave Theory are its drawbacks. 

free online forex course