BOLLINGER BAND TRADING: Simplifying Elliott Wave Analysis

Elliott Wave analysis is a collection of complex techniques. Approximately 60 percent of these techniques are clear and easy to use. The other 40 are difficult to identify, especially for the beginner. The practical and conservative approach is to use the 60 percent that are clear.

When the analysis is not clear, why not find another market conforming to an Elliott Wave pattern that is easier to identify?

From years of fighting this battle, we have come up with the following practical approach to using Elliott Wave principles in trading.

The whole theory of Elliott Wave can be classified into two parts:

•	Impulse patterns
•	Corrective patterns

Elliott Wave Basics — Impulse Patterns
The impulse pattern consists of five waves. The five waves can be in either direction, up or down. Some examples are shown to the right and below.The first wave is usually a weak rally with only a small percentage of the traders participating. Once Wave 1 is over, they sell the market on Wave 2. The sell-off in Wave 2 is very vicious. Wave 2 will finally end without making new lows and the market will start to turn around for another rally.

The initial stages of the Wave 3 rally are slow, and it finally makes it to the top of the previous rally (the top of Wave 1).

At this time, there are a lot of stops above the top of Wave 1.

Traders are not convinced of the upward trend and are using this rally to add more shorts. For their analysis to be correct, the market should not take the top of the previous rally.

Therefore, many stops are placed above the top of Wave 1.

The Wave 3 rally picks up steam and takes the top of Wave 1. As soon as the Wave 1 high is exceeded, the stops are taken out. Depending on the number of stops, gaps are left open. Gaps are a good indication of a Wave 3 in progress. After taking the stops out, the Wave 3 rally has caught the attention of traders.

The next sequence of events are as follows: Traders who were initially long from the bottom finally have something to cheer about. They might even decide to add positions.

The traders who were stopped out (after being upset for a while) decide the trend is up, and they decide to buy into the rally. All this sudden interest fuels the Wave 3 rally.

This is the time when the majority of the traders have decided that the trend is up.

Finally, all the buying frenzy dies down; Wave 3 comes to a halt.

Profit taking now begins to set in. Traders who were long from the lows decide to take profits. They have a good trade and start to protect profits.This causes a pullback in the prices that is called Wave 4.

Wave 2 was a vicious sell-off; Wave 4 is an orderly profit-taking decline.

While profit-taking is in progress, the majority of traders are still convinced the trend is up. They were either late in getting in on this rally, or they have been on the sideline.

They consider this profit-taking decline an excellent place to buy in and get even.

On the end of Wave 4, more buying sets in and the prices start to rally again.

The Wave 5 rally lacks the huge enthusiasm and strength found in the Wave 3 rally. The Wave 5 advance is caused by a small group of traders.

Although the prices make a new high above the top of Wave 3, the rate of power, or strength, inside the Wave 5 advance is very small when compared to the Wave 3 advance.

Finally, when this lackluster buying interest dies out, the market tops out and enters a new phase.

Elliott Wave Basics — Corrective Patterns
Corrections are very hard to master. Most Elliott traders make money during an impulse pattern and then lose it back during the corrective phase.

An impulse pattern consists of five waves. With the exception of the triangle, corrective patterns consist of 3 waves. An impulse pattern is always followed by a corrective pattern. Corrective patterns can be grouped into two different categories:

•	Simple Correction (Zig-Zag)
•	Complex Corrections (Flat, Irregular, Triangle)

Simple Correction (Zig-Zag)
There is only one pattern in a simple correction. This pattern is called a Zig-Zag correction. A Zig-Zag correction is a three-wave pattern where the Wave B does not retrace more than 75 percent of Wave A. Wave C will make new lows below the end of Wave A. The Wave A of a Zig-Zag correction always has a five-wave pattern. In the other two types of corrections (Flat and Irregular), Wave A has a three-wave pattern. Thus, if you can identify a five-wave pattern inside Wave A of any correction, you can then expect the correction to turn out as a Zig-Zag formation.