When a set of asset price movements go against the primary trend, the Elliott Wave method of analysis calls this a corrective wave. According to this theory, price movements will always occur in a predictable cycle with movements being broken into impulsive and corrective waves. An impulsive wave is a price movement in the same directions as the trend, and corrective wave is a movement counter to the trend. Together, both wave types form specific patterns that lie at the basis of Elliott Wave Theory.
How to Identify a Corrective Wave
Unlike Impulsive Waves, which are relatively simple to identify, Corrective Waves are much harder to spot. There is, however, one key rule when it comes to corrective waves – they will never form a five wave pattern. Only an Impulsive Wave is able to form a five wave pattern. However, to complicate the matter further, one, or even more than one, of a Corrective Wave’s subordinate waves can form a five wave pattern.
There are two relevant guidelines for corrective waves:
The first is the Alteration Guideline. This states that if there is a sharp correction at Wave 2, then Wave 4 is most likely to be a sideways, protracted corrections. Should Wave 2 be a sideways, protracted correction, then more likely than not, Wave 4 will be sharp.
The second is the Equality Guideline. This states that both Wave A and Wave C will have roughly equal lengths. This guideline is helpful in determining the likely ending point of Wave C.
Types of Corrective Waves
There are four corrective wave patterns: Zigzags, flats, trianlges and combinations.
A zigzag corrective wave consists of a 3 wave pattern (ABC). This includes subordinate waves of lesser degree making up the zigzag correction. In this type of corrective wave, waves C and A will be impulse waves while Wave B is a lesser degree corrective wave. Zigzag corrections are able to extend, forming double or triple zigzags, each separated by a intervening wave of 3 subordinate waves.
A flat corrective wave will also consist of a 3 wave pattern (ABC), but it will have subordinate waves with a 3-3-5 count. These are distinctly weak corrections, often with wav C failing to exceed Wave A’s length. Often, flat corrections follow strong impulsive waves, occurring more frequently as the 4th rather than 2nd wave. There are 3 subcategories of flat corrections:
Regular – in this variety, Wave B is usually a 100% retracement of Wave A, with Wave C being a little more than a 100% retracement of Wave B. It will end slightly beyond Wave A.
Expanded – these have a shape similar to a megaphone, Wave B going beyond the beginning of Wave A and Wave C going beyond the beginning of Wave B.
Running – these rarely occur, being similar to an expanded flat correction, except that the Wave C will fail to go beyond the beginning of Wave B, and also it will fail to go to the end of Wave A.
A triangle correction will consist of 5 waves (ABCDE), with subordinate waves in a 3-3-3-3-3 pattern. This type of pattern reflects a brief balance between bears and bulls, and often each successive wave will just fall short of a complete retracement of the prior wave. A triangle will also occur as the 4th wave of an Impulsive wave, and usually it will be followed by a small, rapid 5th wave travelling roughly the same distance as the triangle’s widest part.
This corrective wave type is usually horizontal, forming a combination of simpler 3 wave corrections like zigzags, flats or triangles. Often, a combination correction will end with a triangle, but it will never begin with one. Each pattern making up a combination corrective wave will be separated with an intervening wave of 3 subordinate waves. Usually, combination corrections will occur in the 4th wave.
Trading Corrective Waves
When trading a corrective triangle pattern, you should look at the b-d trend line. If it is broken in a shorter time than has been taken for an E wave to form, this indicates the start of a new trend. You should therefore look for a bigger expiry date for your binary options if it has a reversal pattern, or a limited action should it be a continuation pattern.
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