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Step 5: Wave Setups

Chart patterns and indicators tell you what price is doing. They are weak at telling you how mature a trend is. Is this rally just starting, or is it the last push before a fall? Wave analysis, based on the Elliott Wave Principle, helps answer that question.

This step does not try to make you an expert wave counter. It teaches the structure and the rules you need, then focuses on a handful of setups where the wave count gives a clear entry and a clear stop.

Why use waves at all​

Wave analysis helps you:

  • Find the main trend. A five-wave advance is an uptrend.
  • Spot counter-trend moves. A three-wave pullback inside an uptrend is a chance to buy in the trend's direction.
  • Judge maturity. A fifth wave is a warning to take profit or tighten stops. The end of a C wave offers fresh entries.
  • Set targets. Fibonacci relationships between waves give price targets.
  • Place better stops. The wave rules tell you exactly which price would make your count wrong.
  • Filter setups. A chart pattern that fits the wave count has better odds.

How to use waves with the rest of the course​

Use the three-screen method from Step 1 to make the decision. Use waves to filter setups, check them, and fine-tune the stop. Keep it simple, and trade only the clearest counts. When you are in doubt, do not trade.

Lessons in this step​

  1. Wave structure
    • Why markets move in waves
    • The basic five-three pattern, subdivision, and degree
    • The three hard rules
    • Impulse waves, extensions, and truncation
    • Leading and ending diagonals
    • Corrections: zigzag, regular flat, expanded flat, triangles, and combinations
    • The personality of each wave
    • How to tell an impulse from a correction, and where to start counting
  2. Guidelines and indicators
    • Equality, alternation, and depth of correction
    • Channeling and throw-over
    • Volume
    • Post-triangle thrust
    • Fibonacci relationships between waves
    • MACD, the MACD histogram, GMMA, RSI, reverse divergence, and Bollinger Bands on waves
  3. High-probability setups
    • Stop-loss rules from the wave rules
    • Third-wave setup
    • Fifth-wave setup
    • Triangle breakout setup
    • Ending diagonal setup
    • Trading the main trend after the end of wave C
    • Head and shoulders counted as waves, and the failed head and shoulders
    • The counter-trend trade after a completed fifth wave
    • Points to remember, and the wave trade journal

What to do next​

When you can label an impulse, a correction, and one high-probability setup on a real chart, go to Step 6: Futures and options.