How to Trade with Elliot Wave Theory

Elliot Wave Theory is far easier to spot in our diagrams than it is in the markets. Markets don’t always make very perfect patterns. In fact, this is what you might see when looking at an Elliot Wave in action in the foreign exchange market:

As you can see this chart look like a mangled version of our diagrams. But this is an Elliot wave pattern, and you’ll have to spot them, even when they look like that! How can you spot patterns that look so very different from the perfect diagrams? It’s simple; practice!

Identifying Elliot Wave Theory

There are some very basic rules to following in making the most of Elliot Wave Theory:

• Wave 2 cannot break the start of Wave 1.
• Wave 3 cannot be the shortest wave in Elliot Wave Theory.
• Wave 3 is usually, but not always, the largest wave.
• Wave 4 cannot cross into the same general area as Wave 1.
• Wave 5 should, but does not always, make a new high or low above or below wave 3.

If wave 2 breaks wave 1, then the following waves simply won’t follow. If the third wave is the shortest of the bunch, then it cannot be wave 3, and it simply isn’t an Elliot wave pattern. Finally, if wave 4 rises into wave 1’s area during a downtrend, or falls into wave 1s area during an uptrend, then the whole of the Elliot wave is ruined.

This lesson can be far more complicated than it needs to be. One of the reasons it is so complicated to explain with words is because there may be many small waves within one larger Elliot Wave.

In the next lesson we’ll apply what we understand about Elliot Wave Theory to the foreign exchange market to make sense of our trading rules.