Elliott Wave Theory is an approach that is used by market analysts to predict the movement of a stock price. The theory is based on the belief that stock price moves according to a predictable pattern called waves. These waves are grouped into two namely motive waves and corrective waves.
Understanding Corrective Waves
Corrective waves are part of the two kinds of waves that characterize the movement of stock price. Motive waves are the first to be observed and these drive the direction of the stock price (upward or downward). Corrective waves the counter to these motive waves and move in the opposite direction of motive waves. In the 5-wave cycle, corrective waves are 2 and 4. There are several types of corrective waves.
Zigzag Formation
The Zigzag formation happens when the price of a stock moves opposite of an underlying trend in ABC formation, it is called a Corrective wave . Zigzag occurs mostly on the 2nd wave and to a lesser degree on the 4th wave. Zigzag waves (ABC) sub divides into 535 sequence. Zigzag’s retracement is quite strong typically retracing .618 Fibonacci.
Flat Formation
A Flat pattern is another part of a Corrective wave. The Flat pattern consists of ABC as well and it typically occurs in a 4th wave. Flat waves are reflective of a strong underlying trend as it will retrace less of the prior motive wave usually at .382 Fibonacci or .5 Fibonacci. FLAT waves ABC sub divides into 335 sequence.
Triangle Formation
Triangle formation typically occurs in a 4th wave. This wave is also a corrective move that appears on the 4th wave and NEVER on the 2nd wave. It consists of 5 waves inside a triangle and each waves sub divide into 3 waves, so it is 33333 waves that is comprised of a triangle. Triangle hints that there is a final motive wave left within the underlying trend, in other words. a triangle precedes the final move.
Rules and Guidelines of Corrective Waves
Motive and correction waves are subject to a number of rules. These rules help market analysts distinguish between various patterns and especially be able to distinguish between motive waves and corrective waves. Here are some of the rules that govern the behavior of corrective waves:
- The second corrective wave (labeled 2) should never correct more than 100% of motive wave 1. This is because to correct more than 100% would mean changing the direction of the stock price. In such a case the correction would transform into a motive wave.
- In a bull market, 4th wave low cannot overlap with a 1st wave high or in a bear market, 4th wave high cannot overlap with a 1st wave low.
- The alternation guideline says if 2nd wave is a deep retracement expect the 4th wave to be a shallower event. Vice versa, if 2nd wave is shallow expect 4th wave to be a deep event.
- The 2nd wave can Never be a triangle, but within the ABC formation, wave B can be a triangle but the the entire 2nd wave cannot be a triangle.
- Double or Triple three or Double zigzag, triple zigzag and combination typically occur on the 4th wave.
Current Wave Count can assist in counting corrective waves properly. Apply Fibonacci numbers to pinpoint retracement levels.
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