1: Elliott Wave Theory

Elliott Wave Theory interprets market actions in terms of recurrent price structures that follow the
Fibonacci sequence. Basically, Market cycles are composed of two major types of Wave : Impulse Elliott
Wave and Corrective Elliott Wave. Impulse wave can be sub-divided into a 5-wave structure (1, 2, 3, 4, 5),
while a corrective Elliott Wave can be sub-divided into a 3-wave structures (a, b, c).

1. Elliott Wave (1)

2. Elliott Wave (2)
3. Elliott Wave (3)
4. Elliott Wave (4)
5. Elliott Wave (5)
6. Elliott Wave (C)

The Elliott wave theory was born from a set of articles written in the 1930s by R. N. Elliott, from his studies
mainly on the Dow Jones Industrials index – the U.S. Stock Market. He noticed that the market tended to
move in certain patterns. He then surmised that these patterns could be used to predict certain future
price movements. In essence, he noticed that most strong trends tended to unfold in 5 waves in the
direction of the main trend, and which were connected by certain corrective patterns.

He also noticed that when each pattern was complete, it then formed part of a larger-degree pattern. He
also surmised that each pattern not only unfolded as part of a larger-degree pattern but also sub-divided
into a minor pattern where the impulsive swings (the ones in the direction of the main trend) tended to
unfold in 5 waves connected by corrective patterns (the simplest of which was the ABC). He then surmised
that if a market analyst pinpointed where in this pattern the market currently was, then he (or she) should
be able to predict where the market would go from here. In essence, the Elliott wave theory allowed you
to predict future market movements.

This is very different from many technical analysis techniques available today, where most of them are
lagging indicators that show you when a market turn has unfolded in the past. Elliott wave theory is
designed to be predictive in nature and as such should be considered a leading indicator, with the future
movement of a market able to be anticipated, once the current position is established. So, if you were able
to determine accurately where in this current pattern you are, the Elliott wave theory should then be able
to predict where the market should go in the future…….

1. Elliott Wave 1 Theory

Elliott Wave (1) is the first or initial swing off a important high or low.
Elliott Wave (1) is rarely obvious at its inception. When the first wave of a new bull market begins, the
fundamental news is almost universally negative. The previous trend is considered still strongly in force.
Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not
look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the
options market is high. Volume might increase a bit as prices rise, but not by enough to alert many
technical analysts.

As such, Wave (1) is the initial swing off an importnat high or low…

2. Elliott Wave 2 Theory

Elliott Wave (2) is the first correction against the new trend

Elliott Wave (2) corrects wave (1), but can never extend beyond the starting point of wave one. Typically,
the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and “the crowd”
haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for
those who are looking: volume should be lower during wave two than during wave (1). Wave (2) usually
unfolds as a simple 3-swing abc pattern.

As such, Wave (2) is the first correction following the initial swing off an importnat high or low…

3. Elliott Wave 3 Theory

Elliott Wave (3) is usually the strongest and longest wave

Elliott Wave (3) is usually the largest and most powerful wave in a trend. The news is now positive and
fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and
shallow. Anyone looking to “get in on a pullback” will likely miss the boat. Trading the Wave (3) is usually
the most profitable……….
As such, Elliott Wave (3) is usually the longest and strongest in a completed 5 wave sequence

4. Elliott Wave 4 Theory

Elliott Wave (4) usually unfolds as a complex correction

Elliott Wave (4) although being corrective, can be tricky to trade. Prices may meander sideways for an
extended period, and Wave (4) typically retraces less than Wave (2) did. Volume is well below than that of
wave (3). However, Wave (4) can still offer a buying opportunity if you understand the potential ahead for
wave (5).

A such, Elliott Wave (4) is the correction before the final Wave (5) swing.

5. Elliott Wave 5 Theory

Elliott Wave (5) is the final leg before the top

Wave (5) is the final leg in the direction of the dominant trend. The news is almost universally positive and
everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top.
Volume is often lower in Wave (5) than in Wave (3), and many momentum indicators start to show
divergences (prices reach a new high but the indicators do not reach a new peak).
As such, Elliott Wave (5) is the final leg before the unltimate top.

6. Elliott Wave C Theory

Elliott Wave (C) is the end of the correction

Wave (C) is the most important wave in the whole sequence. The reason for this is simple. Because once a
Wave (C) is complete, the whole ABC correction is complete. And when the whole ABC correction is
complete, the prior major trend then resumes. As such, the end of the Wave (C) represents the best point
to enter a new trade…..

As such, Elliott Wave (C) is the end of the correction, before the prior trend resumes.

2: Elliott Wave Rules

Elliott Wave Rules and Guidelines

There are three main rules that most standard Elliott Wave analysts adhere to today:

1. Elliott Wave (2) cannot retrace past the start of Elliott Wave (1)
2. Elliott Wave (3) cannot be the shortest wave in a completed 5 wave sequence
3. Elliott Wave (4) cannot retrace into Elliott Wave (1)
Although these are quoted as rules, Elliott himself (in his original writings) never referred to these as strict
rules, he used phrases like should and rarely to describe them. As such, the label of Elliott wave rules was
probably added in later years in an attempt to make the principle less ambiguous and more structured and
exact.

1. Elliott Wave 2 Rules

Elliott Wave (2) cannot retrace past the start of Wave (1)

If Wave 2 retraces past the start of Wave 1, then it cannot be considered a Wave 2 and the current wave
structure must be reconsidered.

This cannot be considered a valid wave count, because Wave (2) has traded below the start of Wave (1), so
this wave count must be re-considered.

2. Elliott Wave 3 Rules

Elliott Wave (3) cannot be the shortest Impulsive wave

Wave 3 cannot be the shortest Impulsive wave in a completed 5-wave structure.

Here Wave 3 is the shortest Impulsive wave in this completed 5-wave sequence, which would be in breach
of this second rule, so this wave count is incorrect and must be re-considered.
3. Elliott Wave 4 Rules

Elliott Wave (4) cannot retrace into the area of Wave (1)

If Wave 4 retraces into the area of Wave 1, then it cannot be considered a Wave 4, and the current wave
structure must be reconsidered.

Here Wave 4 has retraced back below the high of Wave 1, which would be in breach of the third rule, so
this wave count is incorrect and must be re-considered.

3: General Observations
The section above outlined the three main Elliott Wave rules that should be obeyed in all 5-wave
sequences. Now we would like to look at some additional observations and general guidelines that can
help in placing an Elliott Wave count on a chart.

Corrections and corrective waves do not have a set of rules associated with them, so these general
observations focus on the ideal 5 wave pattern.

1. Elliott Wave (3) is usually the strongest wave

2. Elliott Wave (5) and Elliott Wave (1) are very often equal in price
3. Elliott Wave – The rule of “alternation”
4. Elliott Wave (2) usually unfolds as a simple abc correction
5. Once a 5-wave sequence is complete, the whole sequence is corrected
6. The first leg off the move from a completd 5 wave sequence, oftem finds support/resistance at the
prioe minor Wave (4)
7. Once a correction is complete, the main trend resumes
8. Elliott Wave (4) can retrace into the area of Elliott Wave (1) (slightly)

Now we have finished the specific Elliott Wave rules and also some General Observations, you should be
ready to apply these to some charts. But before you do, we suggest taking a look at the next section on
how to trade Elliott Wave, especially as this outlines how Elliott Wave patterns unfold in todays markets,
and as such, how they are best traded……
1. Elliott Wave 3 observations

Elliott Wave (3) is usually the strongest wave

Elliott Wave rule no:2 stated that Wave (3) cannot be the shortest wave in a complete 5 wave sequence. In
practice, Wave (3) is usually the strongest and longest wave. As wave (3) is usually the longest and
strongest wave it normally carries

Wave (3) very often is the extended wave, where this swing trades beyond what is considered normal in a
completed 5-wave sequence. Again this makes this an ideal wave to trade, because of its large profit
potential.

2. Elliott Wave (1) and (5)

Elliott Wave (1) and Elliot Wave (5) are very often equal in Price

If Wave (3) is the extended wave (i.e. it is the longest Wave) then very often Wave (1) and Wave (5) tend to
be approximately equal in price.

As wave (5) is very often equal in price to Wave (1), once Wave (4) is complete, this allows an easy way to
approximate where the Wave (5) will end.
3. The rule of Alternation

The rule of Alternation There is a general tendency for the pattern of the two corrective swings in a
completed 5-wave sequence to alternate between a simple (very often an ABC) correction and one of the
more complicated or “complex” Elliott corrections.

This is a very helpful observation, because if Wave 2 unfolds as a simple ABC correction then the
probabilities will favour that Wave 4 will unfold as a more complex correction. And vice-versa, if Wave 2 is
complex, then you should anticipate that wave 4 is likely to unfold as a simple ABC pattern.

4. Elliott Wave 2 observations

Elliott Wave (2) generally unfolds as a simple abc correction

In most cases Wave (2) usually unfolds as a simple ABC correction. Or put another way, a simple ABC
correction is found in a Wave (2) correction more often than in a Wave (4).

Again, this is a very useful piece of information, because once Wave (1) is complete, then the most likely
pattern to unfold is a simple ABC correction.

And, because of the rule of alternation, this leads onto Wave (4) usually being the complex correction in a
completed 5-wave sequence.
5. Elliott Wave 5 Complete

Once an Elliott Wave (5) is complete, the whole sequence is corrected

Once the Wave 5 of a completed 5-wave sequence is complete a correction will unfold that corrects the
entire prior 5-wave sequence.

What this means in practice is that once Wave 5 is complete a correction which is larger than any
correction incurred during the prior 5-wave sequence should then unfold.

6. The initial swing

The initial swing off a completed 5 wave sequence will often find support/resistance in the area of the
prior minor Wave (4)

Again, this is a very useful observation as it gives you an approximate target for the first swing of the
correction following the end of a completed 5-wave sequence. In Elliott wave terms this is the Wave (1orA)

Here you can see how the first swing off the Wave (5) high found support "in the area of" the price level of
the prior minor Wave (4). In practice this area is usually slightly exceeded, and support is found just beyond
this prior Wave (4) level, this is usually at the Decision Point (DP) level form the prior Wave (4).
7. Correction is complete

Once a correction is complete, the main trend resumes

Again, this is a very important observation, because it allows you to anticipate that once a corrective
sequence (ideally a simple abc) is complete, it should be followed by a strong and impulsive move in the
original trend direction.

8. Elliott Wave 4 observation

Elliott Wave (4) can retrace into the area of Wave (1) (slightly)

Rule number 3 states that Wave (4) cannot retrace into the area of Wave (1). However, in practice,
particularly in the commodity markets, a small retracement into the area of Wave (1) often happens.

Here Wave (4) has retraced back just below the high of Wave (1), which normally would invalidate this as a
potential 5-wave count. However, in practice you can allow Wave (4) to dip into the area of wave (1)
slightly.

Actually, if the market in question immediately reverses and then moves out of the area of Wave (1), then
this should be allowed as a valid 5 wave count. As you will see later, although this minor breach of the
Wave (1) extreme can be allowed it should not normally happen in a perfect 5-wave count.

As such, when this happens you should treat the wave count as valid but not perfect.

End....
4: Trading Elliott Wave
Elliott Wave Theory and Analysis

At first sight, the Elliott wave theory appears to be perfect – all you have to do is place the appropriate
wave count on the chart, by obeying a few simple rules and guidelines, and then you should be able to
forecast where the market will go next. However, these are carefully chosen examples, and this is where
the problem normally occurs, in that most textbooks and Elliott wave courses use specially selected
examples that are tailored to demonstrate the technique.

However, as we will see in the first section below, things are very different once you enter the real
world………….

1. Enter the Real World – The problems faced

2. The Solution – Isolation Approach
3. Trading the Wave (3)

1. Elliott Wave The problems faced

Trading Elliott Wave – enter the real world

Please understand that the comments in this web site are only a personal observation from my own
experience, but it is one that appears to reflect many Elliott wave analysts I have met during my 30 years
involved in the markets. The normal sequence of events goes something like this…

Firstly, the budding Elliott wave analyst hears about Elliott waves on some chat room or from another
trader, and then goes and purchases an Elliott wave book or trading course. They then spend months
carefully studying all of the rules and guidelines with the aim of becoming fluent in Elliott wave analysis.
They then try to apply the rules and guidelines they have learnt to real and live market examples, normally
with limited success. You can always spot a new Elliott wave analyst because they always have the most
current bar ending some sort of complicated wave structure, with labels of varying degree all over their
chart. They then make a forecast that must be correct because everything is perfect and all the rules have
been obeyed on their chart.

However, the market usually goes the other way, resulting in a trading loss. They usually try this on a
number of charts over a few weeks or months, with most of the charts moving in exactly the opposite
direction to anticipated. Sometimes the Elliott student will have one great success, and call the exact day
of a market turn, which normally makes them deny or carefully forget more of the not-so-good recent calls
on other markets. But usually, at some point, the student admits that most of their calls are not working
out as anticipated.

I have seen this all too often over the last 30 years – Basically, no matter now perfect the current wave
count seems, it very often break down at some point in the future. As such the current forecast you have
does not work out as anticipated.

So why should the theory break down so often? From my own experience I noticed that Markets go
through Cycles, they have periods of clarity, where the pattern is clear and can be used, then they also
have periods of uncertainty, when the pattern is unclear. I call this the "The Cyclical Nature of Trading".
The only practical way round this is to accept that Elliott wave analysis only works about 50% of the time.
In other words, an easy to recognise and obvious wave count only exists on ½ the charts you look at or will
only work about ½ the time while you are looking at one market.
So is there an answer ? And more importantly, can Elliott Wave (with all its shortfalls) be used as a
successful trading approach ? I am glad to say that the answer is yes, please see the next section.

2. The Isolation Approach

Elliott Wave – Isolation Approach

In the last section we saw, that no matter how good the Elliott Wave Pattern looked at the time, more
times than not it broke down and the anticipated forecast did not unfold. The reason for this was that
markets tend to go in Cycles, what I call the “Cyclical nature of Markets”, so any Technical Analysis
approach can only be reliably used about 50% of the time, and this includes Elliott Wave Analysis. So, after
a lot of research it dawned on me that trying to use Elliott Wave in the way it was traditional taught would
never work because the idea of being able to make a forecast 100% of the time in a Market that was only
in a clear pattern about 50% was not sensible. The solution became obvious, what if I only tried to use
Elliott Wave Analysis when the Market pattern was clear? This meant that Elliott Wave could only be used
about 50% of the time, the other 50% of the time (when the Market Pattern was unclear) it was better
doing nothing………. And so my Isolation Approach to Elliott Wave Analysis was born !

For me, this made perfect sense, because as a Trader (rather than an Analysist), all we need to know is how
to uncover a Trade setup, so all we needed was a unique point in time when the Market was in a position
where you could enter a trade with a small control initial risk. In other words, you just needed to know the
pattern at that time. Then you use correct Position Sizing (more on this in other parts of this web site) to
keep the initial risk small. Then over time, if you make trades where the Profits are larger than the losses
then you have the basis for a successful approach to Trading. It did not matter that about 50% if the time
the market pattern was unclear, because as Traders we are not looking to know where the market is going
all the time, we are just looking for Tradable opportunities when the market pattern is clear.

This then formed the basis of my unique Isolation Approach to Elliott Wave.

That is all well and good, I can hear you ask – but how do we know when to start the Elliott Wave Pattern ?
Again, the answer was remarkably obvious, we look to the higher time frame charts. We have all heard
that it is important to make sure your analysis fits in with the higher time frame, so why not use the same
approach with my Isolation Approach to Elliott Wave. Again, from my own research, I discovered areas of
Support or Resistance that very often produced a turn in the market, I called these “Decision Points (DP’s)”.
As such, the best place to start a new Elliott Wave sequence was at an area of DP support / resistance on
the higher time frame chart.

If any of you have studied Elliott Wave before you will know that it can become incredibly complicated
with Alternate Wave counts and complex corrections. But the only reason these have been introduced is to
try and cope with the times when the traditional Wave Theory breaks down. Because we are now only
looking to do Analysis when the market pattern is clear, we no longer need any of these more complex or
confusing parts of the traditional Elliott Wave theory. This then simplified things considerably, where we
can focus on the simplest Elliott Wave Pattern of all, the ABC correction.

This was great, because the most common place an ABC correction unfolded was in the Wave (2), and
what followed a Wave (2) – a Wave (3), which is usually the strongest and longest swing in a completed
Elliott Wave sequence. So, by simplifying the Elliott Wave Theory and only using it in Isolation (when the
Market Pattern is clear) we had the potential to uncover what I (personally), think is one of the best trades
you can get. Being able to enter a market as the Wave (2) is ending (with a small controlled risk) to then be
able to trade what is potentially the longest swing (where the largest profit is available). In other words,
the smallest initial risk for the largest Profit potential.
I hope this gives you an overview of how and (more importantly) why I developed my unique Isolation
Approach to Elliott Wave. To be able to take the best (and simplest) parts of the Traditional Elliott Wave
theory and then apply then into the real world where Markets go through Cycles and their pattern is only
clear about 50% of the time…… My unique Isolation Approach to Elliott Wave then became the basis of the
MTPredictor software program that was launched in 2001.

3. Elliott Wave 3 trade setup

From my 30 years experience in the markets, I believe this is the best Elliott Wave setup there is. From
reading the Elliott Wave Rules and Guidelines, you will have already seen that the strongest Elliott Wave is
Wave (3), this is Guideline No: 1 so that is the best wave to trade. To enter at the start of the Wave (3) we
need a method to enter at the end of the Wave (2). From Guideline No: 4 we have seen that Wave (2)
usually unfolds as a simple ABC. So based on this, if we look to enter a new trade on the end of a Wave (2)
that has just unfolded as a simple abc correction, then we are in the best place to then trade the strong
Wave (3) swing.

So what points do we need to look for ?

First we need to identify an important high or low, which is usually DP Support / Resistance on the Higher
time frame chart. This is the starting point. Then we need to identify the initial swing off this important
high or low, this is the Wave (1). Then we look for the first correction following the initial swing after an
important high or low, This is the Wave (2). Then this initial correction should unfold as a simple abc
pattern.

Let’s see what this looks like:

As you can see, getting in at the start of the Wave (3) allows you to keep your initial risk small, to then take
full advantage of the Strong Wave (3) swing. Now you can see why this is my favourite setup, not because
it has a high % of winners, but because it has the potential for Profits that are much larger than the initial
risk.

End…..