The Elliott Waves Theory allows for great risk reward ratios. Not only traders know where price will go, but they can incorporate the time element too.
Price and time represent the two pillars of the holy grail in trading. Knowing where the price goes and when makes a difference between good and excellent trades.
Here's a quick guide on how to trade with Elliott Waves Theory. Furthermore, the setups explained here have entries, stops and take profit levels based on realistic risk-reward ratios.
In this business, anything between 1:2 or 1:3 represents a realistic approach. It means that for every pip risked, traders look for a double or triple reward.
Basics of Elliott Waves Theory
Elliott found that the market moves in two distinct ways. As such, he started to look at waves as defining impulsive or corrective activity. To be more exact, the market can either form an impulsive or a corrective wave.
An impulsive wave is a five-wave structure. As a rule of thumb, any impulsive wave is labeled with numbers: 1-2-3-4-5
Elliott Waves TheoryOn the other hand, with letters, Elliott showed corrective activity. He referred to corrective waves as three-wave structures. While this is true most of the times, not every corrective pattern literally has a three-wave structure.
The idea behind impulsive and corrective waves was that together, the two make a cycle. It was Elliott's strong belief that the market moves in cycles of different degrees.
As such, one cycle has an impulsive and a corrective wave. Or, as Elliott put it, five waves up corrected with three waves down, in a bullish trend, and five waves down corrected with three waves up in a bearish one.
The cycles of different degrees appear everywhere. For example, in a five-wave structure, labeled 1-2-3-4-5, the 2nd, and the 4th waves show corrections, while the 1st, 3rd and 5th show impulsive moves.
However, the 1st wave of the above impulsive activity must have another five-wave structure of a lower degree. And the 3rd and the 5th waves too.
This is what makes the Elliott Waves Theory a complicated method to trade if the basic idea is not properly understood from the start.
Trading the Third Wave
extended wave must be bigger than 161.8% of the other non-extended waves.
Elliott Waves TheoryIn plain English, it is the longest wave. Typically, the third wave extends.
When this happens, the previous wave (the 2nd one) retraces between 50% and 61.8% of the 1st one. Third wave extensions happen most of the time.
This gives a perfect trade. In a bullish impulsive wave, simply place a pending buy limit order between 50% and 61.8% of the 1st wave. The take profit is 161.8% projected from the end of the 2nd wave, while the stop loss must be where the impulsive activity starts.