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.
Zig Gag Formation
The zig-zag formation happens when the price of a stock moves steeply across the different waves. When this happens, the first corrective wave (wave 2) is usually the shortest in length as compared to impulse waves 1 and 3. Zig-zag waves can be broken down further to sub-waves that follow the same 5 cycle pattern.
In this stock movement, the corrective waves have the same length as the motive waves. Flat waves are typically reflective of strong trends. There is a direct correlation between the stability of a trend and the length of the flats.
Triangle formations are caused by the convergence or divergence of motive waves. In these formations, the 5 waves move in a sideways motion. It is important to remember that these different formations can take place in combination.
Rules 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.
- The second rule to corrective waves is that the second corrective wave (labeled 4) must never exceed the price at wave 1.
- The third rule to corrective waves relates to the length of the first and second corrective waves. The rule states that if the second corrective wave is deep, the second one should be shallow.
- The fourth rule to corrective waves is that the first corrective wave will halt its downward movement one lower degree than the previous 4th corrective wave.
- The fifth rule states that each correction must be fully covered by the motive wave that comes after it.
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