When using the Elliott Waves Theory, one of the most intriguing waves is the X wave. While it is difficult to guess its starting and ending point, the X wave does have one major characteristic and that is that it connects either 2 or more corrective waves in the same degree. E.g. if there are 2 zigzags in a complex correction, the entire pattern will be called a double zigzag and these zigzags will be connected by another corrective wave, which is the X wave.
An X wave can be part of a correction with a small X wave or with a strong X wave and the difference between these two patterns can be found by using Fibonacci retracement in the golden ratio of 61.8%. By using this ratio, it is possible to differentiate between the various correction times and so to choose the correct striking price for an option.
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Complex and Simple Corrections in the Market
It can be difficult to understand the concept of X waves because of the difficulty of knowing whether the market is actually forming a complex or a simple correction. While an X wave is essential for a complex correction, in a simple correction an X wave is not required and the market will start the new wave.
X waves are always corrective and, depending on the correction which comes before the X wave, they are either complex or simple. Usually, however, they will be simple corrections such as zigzags, flats or triangles.
When trading X waves, an investor must first look for confirmation of them from the market, as if the X wave represents a simple correction, there are certain conditions which have to be met in order for the price action to take place. This comes back to the 61.8% Fibonacci retracement level once more, as when trading patterns using the Elliott Waves Theory this golden ratio is key. In this situation, the retracement level must be calculated by taking into account the entire length of the corrective wave that occurs prior to the beginning of the X wave. This can be difficult in the case of a triangle, zigzag or flat, but finding the ending point of this previous correction is essential in order to correctly determine the golden 61.8% retracement level.
It is also important to remember that the X wave can never end above the golden 61.8% ratio. While parts of this wave are permitted to move beyond that area, its end may not.
The financial market will always move in impulsive 5 wave structures that are followed with a three wave corrective structure. However, each impulsive wave has 2 corrective waves in the same degree i.e. the 2nd and 4th waves. If one of these is complex, the other has to be simple and vice versa making the presence of an X wave essential.
How to Trade an X Wave
To trade an X wave, a trader must observe the first correction and then draw the Fibonacci retracement level to find the location of the 61.8% retracement. Once the 38.2% level has been reached, a trader can place a put option with an expiration date based on the timeframe on which the pattern has been formed. As the market moves closer to the golden 61.8% retracement level, trading should increase in aggressivity and even more so as it approaches the 50% level.
Although X waves are tricky to understand, once a good grasp has been obtained of how to trade them, an investor can achieve a lot of success by identifying both simple and complex corrections and know how to find the correct retracement levels in order to know how to execute the right trade.
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