Elliott divided the moves markets make into impulsive and corrective waves. Generalities about impulsive waves were treated on the previous article here at ForexGator.com and this article is dedicated to corrective waves.
Before moving forward, it is vital to understand that corrective waves are more common than impulsive waves as markets spend most of the time in ranges. Therefore, a clear understanding of corrections and how they are forming as well as their implications is key to any successful trading strategy.
There are more possible corrections than impulsive waves and the first classification is being made based on the complexity of a pattern. Therefore, according to Elliott, corrections can be either simple or complex.
Simple corrections are of three types, namely; flats, zigzags and triangles. Out of those three, if I were to pick which one is the most common, then that would be the triangle as it is the most favorite pattern for consuming time.
A flat is a three wave structure and it is always labeled with letters. In fact, as a rule of thumb, all corrective waves, whether simple or complex, are being labeled with letters, while impulsive waves are being labeled with numbers.
In a flat, wave A, is a corrective wave on its own, simple or complex and wave B as well is a corrective wave, both of them being of a lower degree. Wave C on the other hand is an impulsive wave and it should respect all the rules of an impulsive wave we listed on our previous article.
What matters the most in a flat is the retracement level for wave B and it is mandatory for it to end beyond 61.8% level when compared with wave A. So all we have to do is to measure the length of wave A and find the 61.8% retracement as that will be the minimum distance price will travel for wave B of a flat.
There are multiple types of flats based on the retracement level for wave B and the length of wave C as well, and each and every type of a flat suggests a different pattern is about to form after completion.
A zigzag on the other hand, while being still a corrective wave and being labeled still with letters (A-B-C), will have only the B wave a corrective wave, while waves A and C must be impulsive.
Wave B holds an essential role here as well as this time it cannot retrace more than 61.8% when compared with the length of wave A. In other words, after the first impulsive move for wave A, the retracement or pullback will be only minimal, as market is preparing for another rally for wave C of the zigzag.
Like it was the case with flats, zigzags are also of different types. While not that many as the flat pattern, a zigzag tells much about the move to follow as well.
As mentioned earlier, triangles are by far the most common corrective patterns and they are having five legs/segments. All the legs of a triangle are corrective as well and are being labeled with letters (A-B-C-D-E).
Any triangle travels between two trend lines, namely the A-C and B-D trend line. It is vital for any trader to know exactly where each leg of a triangle is ending as this is the only way to know how to correctly draw these trend lines.
There are two types of triangles; contracting and expanding. The most common out of the two is the contracting triangle. The nature of a triangle is being given by the two trend lines; if they are reaching a common point somewhere on the right side of the chart, it is being said that the triangle is contracting. On the other hand, if the two trend lines are diverging, the triangle is an expending one.
By far, the most important trend line is the B-D trend line as by the time it is broken the triangle is assumed to be completed and the new wave/trend must start. Frequently the B-D trend line is being broken in a violent manner and it is retested by the move to come. It should be taken into account though that a retest is not mandatory.
Elliott further classified triangles based on the length of their legs and the structure, but for now this is enough to understand how simple corrections are forming and what their implications are.
To have a complex correction, there is a need for an intervening wave, and its purpose is to connect two simple corrections. More on complex corrections on the next article here on ForexGator.com as the intervening wave, or the X wave, is key for correctly counting waves.