How to draw trend lines with Elliott Wave

September 6, 2016

By Admiral Markets

New wave and ew.png

Dear Traders,

Trend lines offer a wide range of analytical trading advantages – as shown in part 1 and part 2 of our special series.

But trend lines are valuable in other ways too.

Most notably:

…they help identify the start of analytical waves within the Elliott Wave (EW) theory…


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…and they recognize where the waves are expected to finish.

By the end of this article, you will know how to correctly combine trend lines and waves.

So let’s get started.

The first step is to show you how to build a trend channel based on EW, then:

  1. explain the value of such a channel
  2. clarify how the same technique can be used in different conditions.

Sound difficult?

Don’t worry – our explanation is beginner friendly.

You can read more about it offline too, with our free ebook.

Wave analysis ebook

Connecting waves 1 and 3

First of all, let’s start with two key rules for trend lines and waves.

Namely:

  1. lines always require two points on the chart, before you can draw a trend line with EW
  2. waves 1 and 3 are parts (or swings) of the chart, that show strong bearish or bullish momentum.

Keep this in my mind when you scan the charts.

Once you find a stronger third swing than the previous one:

  1. move in the same direction
  2. connect waves 1 and 3 with a trend line, which provides the angle of the trend
  3. draw a new EW trend line, which is exactly parallel to the first line (in step 1)
  4. hook the second trend line to the bottom of wave 2, which is the point connecting waves 1 and 3 (in case of an uptrend i.e. to the top in a downtrend).

EW 1.png

Hopefully you now have a trend channel visible on your chart and have successfully used trend lines with EW pattern.

If you don’t – follow the steps again.

Keep in mind that the steps might seem complicated at first:

…but risk-free practise will make it much easier.

The importance of channel

The channel offers a concrete method for finding support or resistance.

Specifically, it shows traders how to find wave 4.

In wave 4:

  1. a bullish channel indicates that price is expected to receive support at the bottom of the channel, which is the parallel trend line connected to the support point of wave 2
  2. a bearish channel indicates that price is expected to receive resistance at the top of the channel, which is the parallel trend line connected to the resistance point of wave 2
  3. the turning spot at the channel, is literally called wave 4.

As you can see below:

  1. waves 2 and 4 are corrective movements (slow)
  2. waves 1 and 3 are impulsive pieces of price action (quick).

EW 2.png

This technique often works well, but it occasionally has a weakness too.

When?

Most notably:

…if wave 4 turns out to be lengthy consolidation zones.

To counter that problem, you:

  1. add a Fibonacci retracement tool from the end point of wave 2, to the end point of wave 3)
  2. keep an eye on the 23.6%, 38.2% or 50% Fibonacci retracement levels – which are where price should stop if it’s in a wave 4
  3. note that if price does break the 50% Fibonacci level, then it is most likely not a wave 4.

EW 3.png

Next forecasts with wave channels

So now we’ve covered waves 1 to 4, let’s look at wave 5.

Wave 5 marks the end of the trend and the channel.

The good news is:

…you can use more or less the same channel that helped connect waves 1 to 4.

Here’s how.

Firstly, connect waves 2 and 4 then:

  1. hook the second trend line, to the top of wave 3 in an uptrend and the bottom in a downtrend
  2. expect wave 5 to finish at the top of the channel in an uptrend and the bottom in a downtrend.

EW 4.png

Wave 5 does have one specific danger though:

…it tends to lose momentum because the trend is almost completed.

But thankfully there is an effective countermeasure.

To avoid this danger, simply:

  1. draw a third EW trend line that is parallel to the first two trend lines, and
  2. place it in the middle of the channel (the pink line in the image below).

EW 5.png

The third middle trend line offers a safer target spot for the completion of wave 5, than the official target at the top (bull) or bottom (bear) of the channel.

Corrective trend line predictions

Price eventually makes a correction, even within trends.

The neat thing is that traders can also use trend lines, for estimating price corrections.

Remember, trend lines are especially formidable tools for establishing the start and finish of corrections.

Now, to understand trend line predictions – you need to know that corrections take place as:

  1. fast paced price movements called zigzags corrections, or
  2. slower price movements called sideways corrections.

During a zigzag correction, traders can exercise the same steps as mentioned for determining other waves – but alter by connecting different highs and lows.

For example:

  1. connect the trend line between a:
    1. top and lower high, during bearish reversal of the uptrend
    2. bottom and higher lower for bullish reversal of the downtrend
  2. draw a second trend line, which is exactly parallel to the first line
  3. hook the second trend line to the:
    1. bottom in bearish reversal
    2. top in bullish reversal
  4. note the main target (see green checks in below image), is the
    1. support trend line in bearish reversal
    2. resistance trend line in bullish reversal ( see the green check in image).

EW 6.png

During a sideways correction, traders can connect various tops and bottoms – to determine a wide range of EW chart patterns.

Please view our dedicated webinar, for a full overview of all the available patterns.

If you have already used trend lines and waves – I would love to hear about your experience in the comments below.

Cheers and safe trading,

Chris
Article by Admiral Markets

Source: How to draw trend lines with Elliott Wave


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