a) Motive waves
b) Corrective waves
Take a look at the snapshot below to make out the part of the Elliot wave that constitutes the motive waves, and the part which constitutes the corrective wave. In this piece, we tackle the motive waves and their relevance to traders.
Motive Waves
Motive waves constitute the first 5 waves in the conventional 8-wave pattern that was initially described by Elliot. The motive wave is the wave component which moves in the direction of the trend. Within the motive wave, there are two short retracements, corresponding to wave 2 and wave 4. Motive waves can occur in bullish and bearish markets, and this is demonstrated below.
The big question that must be asked here is this: what is the relevance of the motive wave to a trader’s trading plan? After all, the motive wave is not just there for the sake of being there. It must surely be put to some kind of use by the trader.
The motive wave may present opportunities to trade with the prevailing trend until the trend ends. This means that there are opportunities to buy at the commencement of waves 3 and 5 in an uptrend, and opportunities to sell at the start of waves 3 and 5 in a downtrend. It is not as easy as it looks. It is important to have an idea as to where a wave will start and end, because these things do not just pop straight out of the charts.
Rules
There are only a few main rules that govern the Elliot wave principal, and a number of guidelines. While the rules are hard and fast, the guidelines are left up to the trader’s interpretation. The rules only apply to the impulse waves and not the corrective waves:
Rule 1: Wave 2 cannot retrace more than 100% of Wave 1.
Wave 2 cannot move below the low of Wave 1. A break below this low would call for a re-count.
Rule 2: Wave 3 can never be the shortest of the three impulse waves.
Even though Wave 3 is typically the longest of the three impulse waves, there is a specific rule that it cannot be the shortest. 1 or 5 can be longer than Wave 3, but both cannot be longer than Wave 3. It is probably best to use percentages or log scales when measuring Wave length. Elliott Wave indicates that Wave 3 must exceed the high of Wave 1. Failure to exceed this high would call for a re-count. Impulse moves are all about making progress. Failure to exceed the high of Wave 2 would not be making progress.
Rule 3: Wave 4 can never overlap Wave 1.
The third, and final rule, is that Wave 4 cannot overlap Wave 1, which means the low of Wave 4 cannot exceed the high of Wave 1. Such a violation would call for a re-count.
Guidelines
In contrast to rules, guidelines should hold true most of the time, not necessarily all of the time. There are numerous guidelines, but we will focus on three key guidelines.
The first guideline is that wave 3 is the longest of the impulse waves within the Elliot wave structure. Wave 5 is generally the same length as wave 1. The second guideline is that wave 2 and wave 4 will alternate in terms of their corrective nature. For example, if wave 2 is a sharp correction, wave 4 will be a flat correction. The third guideline is that following a surge in wave 5, the correction ABC usually ends in the prior wave 4 low point.
The guidelines are very useful in targeting the end of specific waves. In a large uptrend you can use percentages to target the end or beginnings of each wave. For example, the percentage decline in wave 1 could be applied to the high or wave 4 or wave 5. Each guideline is helpful. The third guideline is helpful in estimating the end of the wave 2 correction.
Trading with the Motive Waves
The only way to trade the motive wave is to buy on the dips and sell on the rallies. In other words, sell at the start of waves 3 and 5 in a downtrend, or buy at the start of waves 3 and 5 in an uptrend. Fibonacci ratios may help to identify these points, using the retracement tool to plot from the start of wave 1 to the end of wave 1. The Fibonacci expansion tool may also be used in this manner to derive the possible points at which wave 3 will come to an end (the profit target).
Our motive wave is as shown above. A Fibonacci retracement trace from the start of wave 1 to the end of wave 1 brings up the 38.2% retracement line as the point where the retracement wave 2 ends. The long entry can be made here and followed to the end of wave 3, which can be deduced by using the Fibonacci expansion tool.
This trade must be practiced thoroughly on a demo platform before it can be used on an account with real money.
Please note that the example above is only meant to illustrate the use of motive waves in an Elliot wave structure.
Traders may improve their counting by applying the 3-rules and 3-guidelines to their wave counting. If you apply the rules for the first count and guidelines for the second you are likely to evaluate the waves in the proper manner. By eliminating false waves you may be able to target specific areas of a trend and improve levels to initiate a trade or take profit.
Trading Gaps
Gaps are spaces left on the bar chart where no trading has taken place. Gaps can be created by factors such as regular buying or selling pressure, earnings
announcements, a change in an analyst’s outlook or any other type of news release.
An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move. A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.
