Here’s a step-by-step explanation of Elliott Wave Theory:

1. Understanding the Basics

• Wave Structure: Elliott Wave Theory suggests that market movements occur in repetitive cycles of impulse and corrective waves. The fundamental structure includes:
  • Impulse Waves: Move in the direction of the prevailing trend, typically consisting of five waves (labeled 1, 2, 3, 4, 5).
  • Corrective Waves: Move against the trend and consist of three waves (labeled A, B, C).

2. Identifying Impulse Waves

• Five-Wave Structure: In an upward trend, the five-wave structure is:
  • Wave 1: The initial move up.
  • Wave 2: A correction that retraces part of Wave 1.
  • Wave 3: The most significant upward move, typically longer than Waves 1 and 5.
  • Wave 4: A corrective wave that retraces part of Wave 3, often showing less price movement than Wave 2.
  • Wave 5: The final move up, completing the impulse sequence.
• Trend Direction: In a downtrend, the structure is similar but inverted (5 waves downward).

3. Identifying Corrective Waves

• Three-Wave Structure: After the completion of five impulse waves, a corrective phase typically follows:
  • Wave A: The initial move down.
  • Wave B: A rally against the downtrend, often retracing part of Wave A.
  • Wave C: A continuation of the downtrend, completing the correction.

4. Using Fibonacci Ratios

• Retracement Levels: Elliott Wave practitioners often use Fibonacci ratios to identify potential levels for corrections:
  • Wave 2 typically retraces 61.8% of Wave 1.
  • Wave 4 may retrace 38.2% of Wave 3.
  • Wave C often equals Wave A in length or can be 161.8% of Wave A.

5. Wave Degrees

• Different Time Frames: Waves can occur at various degrees (or time frames), from smaller intraday waves to larger cycles spanning years. Each wave can be subdivided into smaller waves.
• Labeling Waves: Higher degree waves are labeled with Roman numerals (I, II, III, IV, V) and lower degree waves with Arabic numerals (1, 2, 3, 4, 5).

6. Rule of Alternation

• Wave Characteristics: The theory suggests that if Wave 2 is a simple correction, then Wave 4 is likely to be more complex, and vice versa. This helps in anticipating the nature of upcoming waves.

7. Wave Guidelines

• Wave Relationships:
  • Wave 3 is never the shortest wave in an impulse sequence.
  • Wave 2 never retraces more than 100% of Wave 1.
  • Wave 4 should not overlap with Wave 1 in an impulse wave (except in diagonal patterns).

8. Practical Application

• Chart Analysis: Begin by identifying the larger trend using higher time frames. Then analyze lower time frames to identify the wave structure.
• Trade Entry and Exit: Use identified wave patterns to determine entry and exit points. Enter trades during Wave 2 and Wave 4 corrections, aiming to ride Waves 3 and 5.

9. Combining with Other Tools

• Confluence: Use Elliott Wave Theory in conjunction with other technical analysis tools (like Fibonacci retracements, moving averages, or trend lines) to enhance analysis and confirmation.

10. Continuous Learning and Adjustment

• Market Adaptation: Market conditions change, and new patterns may emerge. Continuously adjust wave counts as new price action unfolds.
• Practice: Gain experience by analyzing historical charts to recognize wave patterns and improve your ability to identify future wave movements.