Analysis Toolbox – Corrective Wave Characteristics

This article in The Trader’s Indicator Series discusses Corrective Wave Characteristics, one of the Elliott Wave market cycle categories. The previous article discussed Trend Wave Characteristics, which is the market cycle that traders should be involved in. Since market cycles are also an integral component of the trader’s toolbox and crucial for manual trading, it will be useful to gain an understanding of how price action fits into these cycles as well.

In the last series, called The Trader’s Pendulum, we took you through the 10 Habits, all aimed to support a successful trader. Your mission in developing these habits is to get out of the Technical Trader’s Trap and transform into an Entrepreneurial Trader so that you can start being accountable to your trading. We invited you to take action and begin your journey by completing the Trader’s Scorecard (www.fxtradersedge.com/scorecard) and to get down to business by arranging a free coaching session. In this Indicator Series, we talk about the mechanics of trading.

Corrective Wave Characteristics

Corrective waves have their own personalities as illustrated in the figure above.

Wave A kicks off the corrective move. Whether it’s wave 2, wave 4, or simply the A-B-C following the larger 5-wave sequence, the characteristics are the same. This is the wave where traders are convinced that there is just a simple pullback before the next leg of the move up in the case of an uptrend. Wave A sets the tone for wave B. If A travels in 5 waves, the correction is likely to go deep as a zig zag move. If A travels in 3 waves, then the correction is likely to be a sideways correction like a flat correction or a triangle.

B waves are usually bull traps. After wave A, the market looks to re-buy the uptrend, not recognizing that the correction isn’t over yet. The market gets very euphoric about the continuation of the trend and the move up after wave A can be quite weak and corrective—a big disappointment! However, a 5-wave move in wave A followed by a 3-wave correction in wave B, provides a great setup for positioning for the wave C move down.

Wave C is often called the killer wave, for it can be just as strong and long as a wave 3. It knocks all the long positions out of the way in the case of a prior uptrend. But once wave C is done, the trend will continue. Targeting the end of wave C is a good time to go long again. However, a highly profitable trade is to sell the corrective wave B pullback to be able to ride wave C.

Riding wave C is one of my favorite trade setups. This is also called the equality trade, because the conservative measuring objective for wave C is the distance that wave A travels.

Understanding the wave personalities of the complete 8-wave market cycle is a start to learning the Elliott Wave patterns that occur repeatedly in every time frame and with all market instruments. We call this pattern repetition the “fractal” nature of the markets because the 8-wave structure is similar when scaled in different time frames.

Before we leave Elliott, it is important to note the three Elliott rules that cannot be broken, or else the wave count is invalidated:

  1. Wave 2 never retraces more than 100% of wave 1;
  2. Wave 3 is never the shortest wave; and
  3. Wave 4 does not enter the same price territory as wave 1.

Elliott wave strategists attempt to label and count the waves to find market context for the next major move. Understanding how to read analysts wave counts is a skill that can be learned through the study of Elliott Wave analysis. Internalizing the wave personalities is a good place to start.

You have now completed your mentoring session which covered the analysis toolbox in the last 10 articles of this series which is essential for building strategies and trade plans.

If your mission is to become a trader or investor who stays out of the Technical Trader’s Trap, then take the leap to grow into an entrepreneurial trader.

I created the FX Trader’s EDGE Coaching Program modelled after the “10 Habits of Successful Traders”, which is the title of my newly published book by Wiley.

Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Trader’s Pendulum: The 10 Habits of Highly Successful Traders.  Copyright (c) 2015 by Jody Samuels.  This book and ebook is available at all bookstores, online booksellers, and from the Wiley web site at www.wiley.com.

Leave a Reply

Your email address will not be published. Required fields are marked *