Plenty of chart watchers and students of different techniques become confused and intimidated when it comes to the Elliott Wave Principle. While it may seem a daunting task going through the literature and practicing the labelling, if one focuses only on the 5-major patterns, understands the 3-core rules and a few guidelines then the trader will be armed with a powerful market forecasting tool. Furthermore, EWP, in itself is a detailed description of how markets behave, and as such, provides context for market analysis (Elliott Wave Principle: Key to Market Behavior), something that any other theory lacks. This article is broken down in two parts:
Part 1 will explain what the zig-zag is, its guidelines and a few examples;
Part 2 will provide real-trading setups.
In another article, we have written about the 5-core Elliott Wave patterns and described one of them in more detail, which we suggest you go and study before you continue reading further below: 5-Core Elliott Wave Patterns.
Part 1: What is a zig-zag?
According to EWP, markets behave in two modes: motive and corrective. Any trend, either up or down, falls into the motive category. Any pause of such trend, either shallow or steep, falls into the corrective category.
Motive types: Impulsive & Diagonal
Corrective types: Zig-zag, Flat & Triangle
In this article, we will focus on one of the corrective patterns, the zig-zag A-B-C. The A-B-C pattern has the following elements:
Two motive waves (A & C);
One corrective wave (B).
Each motive have has 5 sub-divisions or sub-waves, labelled with numbers 1-2-3-4-5;
The corrective wave B has 3 sub-divisions, labelled with letters a-b-c;
Usually, wave B of a large zigzag corrects around 50.00%-61.8% of wave A and sometimes 78% but not more than 90%.
As a guideline, wave A equals wave C. You can use Fibonacci extension to measure the moves.
Price action inside a zigzag is usually contained within a parallel channel.
Zigzags can be double and triple. In such instances, each zigzag is labelled as w-x-y (double) and w-x-y-x-z (triple).
Wave B can take any corrective form: another zigzag, a flat, or a triangle.
The purpose of the zigzag, as a steep and fast corrective pattern, is to provide a temporary pause to the primary trend, usually triggered by quick profit taking. After the A-B-C is recorded, the primary trend usually resumes in search of new price extremes.
Example of a Simple Zig-Zag in an Uptrend
In Figure 2.1, you can see an example of a simple A-B-C zigzag following the proper guidelines, such as price action contained within a parallel channel, equal length between wave A & C, wave B retracing 50%-61.8% of wave A. Whereas, in figure 2.2, we have provided a steeper version of a zig-zag where wave C = 161.8% of wave A and the lower-bound of the channel is broken to the downside taking out most of the previous buyers' stop losses.
As long as the above parameters are satisfied then you will have to consider the pattern as a zig-zag and trade it accordingly. The downtrend zig-zag is the reverse of the uptrend, where the A-B-C pattern will correct the downtrend by bouncing higher (see figure 2.3)
In the following example, we see a steep retracement in $EURUSD after market advanced higher for several hours. Price retraced close to the previous market structure in a sharp a-b-c pattern where wave ((C)) = 1.618% x wave ((A)) and then was followed by higher highs (see figure 2.2 again):
Example of a double zig-zag
If a simple a-b-c pattern is not followed by a clear impulsive move towards the direction of the primary trend but instead you notice another corrective move with 3 sub-waves then we have reasons to assume a longer correction in the form of a double zig-zag, such as, a-b-c - X - a-b-c, where wave X can be any form of a 3-wave correction (usually, it is another zig-zag).
Same Fibonacci relationships and channel guideline hold true for this type of zig-zag too. Wave W = wave Y usually at 100% extension, however, when markets are highly volatile and emotional, we can see wave Y extending at another Fibonacci multiple: 123.6%, 138.2% and 161.8% (usually in a wave 2 of a larger degree).
The following is a recent example in $EURUSD again where market provided us with a double zig-zag where wave ((Y)) = 123.6% of wave ((W)). The channeling technique did not assist us here, however, if you were using Fibonacci retracement on each sub-wave, you could have traded the entire correction and then position in a buy at 1.1296 level and boarded the train towards the next station:
Example of a triple zig-zag
The triple zig-zag is the endless stop hunting counter-trend move the market usually develops when there is heavy profit taking or immense pressure against the primary trend with only one goal: shake-off as many previous buyers (in the case of an uptrend) as possible by taking their stop orders before commencing the next strong rally higher (see figure 2.7):
Let's take a look at a recent example in $USDJPY which we were tracking a few months ago. If you had been a buyer in March 2020 on that strong bounce off of the 101.24 lows then chances are high that the market would have hunted your stop loss if you had one. The triple zig-zag took 8 months and made this pair untradeable on lower-timeframes until price finally broke above the 105.65 resistance - previous wave ((X)). That was a confirmation that the market had bottomed and the triple zig-zag was recorded.
Part 2: How to trade a zig-zag?
In our experience, it is always better, easier and less stressful when you focus on trading only motive waves as they are strong and impulsive moves in the direction of the primary trend. As we discussed in our first article, 5-Core Elliott Wave Patterns, motive waves include a 5 move sequence in the direction of the trend. Hence, waves 1, 3, 5, A, and C are what we want to be trading in all cases.
Simple or double zig-zag, we want to be trading the beginning and the end of wave (C) in most cases. By using Fibonacci retracement (the Golden Support) and Fibonacci extension (The Ninja Targets), you will be able to pin-point favorable Risk : Reward (RR) trades. Let's take a look at the $US30 - Dow Jones Index, 15 minute chart:
The chart above shows a clear text-book example of a double zig-zag (w-x-y) and plenty of tradeable setups, all of them inside the impulsive waves of the correction and a few once the zig-zag was recorded and finished. It is true that in hindsight it may seem clearer than in real-time, however, we can guarantee you that if you use the Fibonacci retracement and extensions together with wave development, finding such entry points will become quite simple.
The next chart shows a real-time trade setup again in $US30 - Dow Jones 5 minute chart. We had two opportunities to play this simple ((A))-((B))-((C)) pattern.
The first trade was a short right after wave ((B)) terminated at 50% Fibonacci retracement of wave ((A)) with target at 100% extension where wave ((C)) = ((A)), however, price found support and bottomed at 78.6% extension instead.
The second trade was after the market bounced off of that extension where we positioned long with first target at wave ((B)) high and second target above daily high.
As you can see, trading with zig-zag patterns is another way how you can put Elliott Wave principle into practice and increase the odds of timing the move. In this article we have explained the second core pattern. There are three left to cover in the future. If you want to read the first core then start here --> 5-Core Elliott Wave Patterns: Core Pattern #1.
Practicing EWP and Fibonacci takes time and patience, nevertheless, if you love trading you will get the hang of it. We cover such patterns on a daily basis with a tight team of traders, hence, if you want to learn with us, we suggest you join our telegram channel. If not, simply stay subscribed. Should you have any questions, do not hesitate to pop us an email at firstname.lastname@example.org.