The Elliot Wave principle is a theory that seeks to describe group psychology or how people behave when they are in a group.
The Zigzag Elliott Wave Theory: What is It and How Does it Work?
Ralph Nelson Elliott established this theory after observing that the financial markets behave the same way human beings behaved. He used his deduction to develop a logical system of analyzing the financial markets.
As part of developing his theory, Elliott noticed 13 waves or movement patterns that are repetitive and occur at certain price points. He named these patterns the Elliott waves. Each wave is connected to the other to form a large, ongoing pattern, with each next wave larger than the previous one.
How is the Elliott Wave Theory Applied in Financial Markets?
Elliott’s Waves are a reflection of investor behavior, which is the driving force of the stock markets. Look at it this way: Markets are in constant flux; prices fall today and rise tomorrow. In a way, a visual representation of the financial market would be a zigzag or wavy shape. Changing investor behavior is reflected by changes in the wave pattern. By identifying a recurring pattern, you would be able to forecast the price movement of an asset
However, the predictions you make based on the pattern is just a probability. Advanced traders who are fully familiar with Elliot Wave theory are able to observe the markets and predict what move the markets are likely to make and what move they will not make going forward. There is very little risk involved when using this pattern to assess market movements.
The Elliot waves have a distinct form. Notably the first part of the pattern is made up of 5 waves. Although there are different variations of Elliott wave patterns, the 5 waves are the archetype. Indeed, the stock market always takes the shape of these five waves. This basic pattern is also known as the impulse pattern; each of the five waves moves up or down depending on market sentiments.
The Zigzag Correction
The Zigzag correction consists of three-waves where the second wave after the fifth wave (call it wave B) does not go lower than 75% of the wave that immediately follows the fifth wave in the pattern (call it wave A). Wave A of this Zigzag correction pattern always consists of three waves. Therefore, identifying a wave pattern that contains five waves within the wave, you will have correctly identified a zigzag pattern.
In a bullish market, the zigzag correction is observable as a pattern in decline with a sequence of 5 waves, 3 waves and another five waves. As mentioned above, the highest point of wave B is usually lower than the starting point of wave A. Meanwhile in a bearish market, the zigzag pattern is reversed to form an inverted zigzag correction.
Overall, the zigzag is the only type of simple correction but there are many complex correction patterns. Corrections are generally difficult for novice traders to master. Traders who use the Elliott wave theory usually make profits at the formation of an impulse pattern but lose it following corrective pattern. An impulse pattern, made up of five waves always precedes a corrective pattern, such as the zigzag pattern.
Elliot Zigzag Wave Rules
There are four simple rules: Wave’s B retracement has to be no more than 61.8% of Wave A, Usually Wave C is equal to Wave A, Wave C must extend beyond Wave A, Wave B never goes beyond the start of Wave A.
Double and Triple Elliot Zigzag Waves
Sometimes can occur that zizgag can become double or triple in succession. So explain next figure labeled with X, W, Y. In every double zigzag wave each individual wave is separated by X.