When an investor is observing a 5 wave structure, or expecting one to occur in the financial markets, they should proceed with extreme caution. This is because the outcome is dependent upon which is the largest wave and application of the 161.8% Fibonacci extension is essential. The principle of alternation is key here as it must be respected by both corrective waves (i.e. the 2nd and 4th) and without it, there will be a move that channels very well. The channelling is the initial clue that the market is actually in a corrective phase and in fact is not trending with an impulsive move.
Once this has been observed, a trader must measure the entire length of the 1st wave and then project it to the upside from the ending point of the fourth wave in an impulsive bullish move. This is the spot at which they should expect the fifth wave to end and they should either purchase put or call options depending on the time frame over which the impulsive move has formed.
It is however important to bear in mind that during an impulsive move of this time, once the 5th wave has been completed the price must return to the end of the prior third wave.
Third Waves of Impulsive Moves are Impulsive on Their Own
These extensions are the most commonly seen setup for an impulsive move, and virtually every impulsive wave will have a 3rd wave extension. This 3rd wave extension will usually follow a time consuming, long 2nd wave. Frequently the 2nd wave will be the most time consuming of all the impulsive moves and by juding its structure, an investor can get a good idea about what is likely to follow once the 3rd wave has been completed.
The 3rd wave of an impulsive move must be impulsive on its own, giving traders the most vital clue of all. They should go to the lower time frame and count of a lower degree in order to see if the 3rd wave extension of a larger degree is actually the correct identification and all the essential rules have been respected. If it is indeed a genuine 3rd wave extension impulsive move the 0-2 trend line will confirm it.
The 4th wave which follows a 3rd wave extension will be a short one, while the 2nd will be complex and lengthy. It will rarely retracement further than 38.2% as compared to the entire 3rd wave’s length and therefore, a trader should place call options at the 38.2% level in the case of an impulsive move or put options for a bearish one.
Observing the Fifth Wave
As 5th wave failures are extremely rare, by default, the 5th wave that follows will take the highs of the prior 3rd wave during an impulsive bullish move or the lows for an impulsive bearish move. If this occurs, the trader should look out for a striking price for reversing options. To find this striking price, they should measure the entire first wave’s length and subtract 61.8% of it as this usually indicates the 5th wave’s length. They should then trade a put option for a bullish move or a call option for a bearish one.
Should the 5th wave continue advanced past that level, this indicates that the market is heading towards 161.8% level of wave 1 and more aggressive trading is required.
When interpreting the 5 wave structure, it is important to ensure that the 3rd wave is not the shortest as this is practically impossible, invalidating every scenario.
Although trading using the Elliott Waves Theory can be complex, when a trader uses the Fibonacci tools they can achieve excellent success.
Other educational articles:
- Elliott Waves – The Implications Of A Running Correction To Reduce The Risk Of Painful Trading
- Elliott Waves – Insights For Trading The 2-4 Trend Line Break To Increase Your Profits
- Elliott Waves – How To Trade 5th Waves Extensions Impulsive Moves
- Channelling With Impulsive Moves: Elliott Waves Simple Trading Theories Leverage Your Profit In Binary Options Trading
- Trading The Apex Of A Triangle For Profitable Binary Options Trading
- How To Use The Principle Of Alternation To Profit From Differences Between Corrections
- The financial Logos: The framing of financial decision-making by mathematical modelling, Fondation Maison des sciences de l’homme, 190 Avenue de France, Paris 75013, France
- Mathematical analysis of investment systems, Q.J. Zhu, Western Michigan University, Kalamazoo, MI
- Introduction to convex optimization in financial markets, Teemu Pennanen