- Impulse waves and diagonals — which move in the direction of the larger trend, and…
- Zigzags, triangles and flats are corrective waves — which move against that trend
Understand that each wave pattern implies a path for future price movement. For example, a completed 5-wave impulse implies that before moving higher, prices will first “correct” into the territory of the 4th wave:
A correction can take on a form of azigzag, triangle or flat (or their combination). You don’t know which of these three patterns will develop. But you do know that corrections are just “pauses” within the larger trend. So, once a correction ends, it’s fully retraced by the resuming trend:
Let’s look closer at a zigzag.
A zigzagis a three-wave move (labeled ABC) typically contained by parallel lines, which I call the corrective price channel (above).
How do you spot a zigzag?
Well, if you see a five-wave impulse followed by a three-wave decline where, ideally, wave C equals the length of wave A, it’s probably a zigzag. Remember, all zigzags, flats and triangles are “destined” to be fully retraced.
For example, the May-September 2013 pullback in SolarCity Corporation (SCTY) showed three waves, where waves A and C were roughly equal — a zigzag. Once it ended, we knew to expect a rally above the May 2013 high:
Another example: Pfizer, Inc. (PFE). Here, we saw a triangle — a wedge-shaped countertrend move (labeled ABCDE):
As you can see, when I published this PFE chart in October 2013, the triangle was incomplete. It required a finished wave D and a final decline in wave E. Even so, this wave structure already told you that the larger uptrend in PFE was intact.
Consider: without looking at Pfizer’s earnings, CEO’s statements, or any other “fundamentals,” you knew — just by looking at this price chart! — that new highs beyond $31.15, the point where the triangle began, would ultimately develop!
The forecasting ability of Elliott wave analysis is often truly amazing.
But how do you know where a correction may end — and the larger trend will return?
Answer: The length of corrections often follows Fibonacci ratios. In fact, Fibonacci ratios between waves are the mathematical basis of the Elliott Wave Principle.
Wave 2 and 4 within a basic Elliott wave impulse (labeled 12345) are always corrective. Here, the chart on the left shows you a wave 1 followed by corrective wave 2:
A second wave often retraces a Fibonacci .618 of the first wave — a.k.a. the “Golden Ratio,” also commonly seen in architecture, art, and even the human body. Second waves may also retrace .786 of wave 1, or 50% — but .618 is more common. Fourth waves are usually shallower: commonly, a Fibonacci .382 ratio of wave 3, or even 0.236. (See chart on the right, above.)
Let’s look at another real-life example. Here’s a 5-wave impulse in the S&P 500. Wave 2 is a flat. It made a deep retracement, close to .618. On the Fibonacci table (in red) you can see the .382, .5, .618, and .786 retracement levels. The .618 retracement was at 1087.75 — and the S&P made a low at 1090.19!
Wave 4 is a zigzag. It made a shallower retracement of wave 3, just beyond the .382 mark at 1169.1, bottoming at 1163.75:
There’s a lot more to learn about Elliott wave analysis. But I hope that this article showed you that a) Elliott is not as complicated as it may seem, and b) It works. Not always, not 100% of the time (what does?) — but if you’re looking for a practical “map” of where your market should move next, in my experience, Elliott waves will illuminate your way better than most forecasting methods out there.
Jeffrey Kennedy is the Chief Commodity Analyst and a Senior Trading Instructor at Elliott Wave International, with 20-plus years of experience as an analyst, trader and teacher. He writes and edits Commodity Junctures, EWI’s commodity-forecasting package. He also produces Elliott Wave Trader’s Classroom, an educational service that shows how to spot trading opportunities. Jeffrey has taught Elliott to thousands of traders throughout the U.S. as well as in London, Paris, Zurich, Mumbai, Johannesburg, Melbourne, Singapore and Hong Kong. He is an adjunct professor of technical analysis at the Georgia Institute of Technology (Georgia Tech).