Elliott Wave Theory in Crypto Trading: An Introduction

Elliott Wave Theory in Crypto Trading: An Introduction

As Bitcoin and the broader crypto market exhibit wild fluctuations, many resort to tools like Elliott Waves (EW), which have proven to be valuable tools for analyzing crypto markets and comprehending the price movements of various cryptocurrencies. They are a concept derived from Elliott Wave Theory - a technical analysis that looks into recurring long-term price patterns linked to persistent shifts in investor mood and psychology. Ralph Nelson Elliott developed it in the 1930s after observing and identifying recurrent, fractal wave patterns that could be used to depict price fluctuations in the financial markets.

Elliott Waves are still the most widely used and historically significant technical analysis method in forex trading and other financial markets, including cryptocurrency markets.

Given that the Elliott Wave theory is still one of the most efficient technical analysis methods found to date, a deeper understanding of it stands to be an excellent asset for crypto traders. It may be pretty challenging initially, but once you get the hang of it and become more experienced with Elliott Waves, they become the most valuable tool for Bitcoin and crypto traders.

How does Elliott Wave Theory work?

There are numerous types of waves, or price structures, within Elliott Wave Theory from which crypto investors can get varied insights. However, there are primarily two types of waves in Elliott Wave Theory, as defined by Elliott: motive waves and corrective waves.

Motive waves have a five-wave structure and are those waves that move in sync with the existing trend. Corrective waves, on the other hand, have a three-wave structure and are typically those that move in the opposite direction of the trend.

The following are the three major rules that define the formation of motive waves:

  • Wave 2 cannot retrace more than 100% of Wave 1

This essentially indicates that Wave 2 will never be able to move beyond Wave 1's origin. Wave 2 does not break the bottom of Wave 1 in an uptrend, and Wave 2 does not break the top of Wave 1 in a downtrend.

  • Wave 3 will never be the shortest of Waves 1, 3, or 5.

Wave 3 is usually – but not always – the longest and never the shortest of the entire sequence, and it always ends after Wave 1 reaches its peak.

  • Wave 4 can never overlap the end of Wave 1.

This essentially means that Wave 4 will never retrace more than 100% of Wave 3.

Identifying Waves - the ABC pattern

The ABC pattern, commonly known as the corrective wave, is a 5-wave pattern correction. It's arranged in a three-wave counter-trend design. The five motive waves are numbered 1-5, whereas the three corrective waves are lettered A, B, and C, as shown in the chart above.

While Elliott has specified about 21 different corrective ABC patterns in his book, crypto traders frequently trade using the most common and most straightforward ABC patterns, such as the Zig-zag pattern, flat formation, or triangle formation.

Wave 1, Wave 3, and Wave 5 are the three motive waves that influence directional movement. In terms of crypto, this means that if your crypto asset is rising, these three waves will rise with it. Because the two corrective waves - Wave 2 and Wave 4 - are counter-trend waves, they will go downwards and retract the price of your crypto asset if the market is trending upwards.

Crypto traders often use the “5-3 move,” which occurs when both motive and corrective waves come together. It can occur on all time frames from 1 minute to a year.

Let us look at this through an example of the following BTC/USD chart.

In order to validate the 5-wave move that enables trading decisions, the waves must satisfy and abide by the three rules previously mentioned. Keeping in mind these three rules of motive waves, we can observe that:

  • The correction in Wave 2 does not break the bottom of Wave 1. Hence, Wave 2 does not retrace more than 100% of Wave 1.
  • This is followed by a much larger surge upwards in Wave 3. Hence, Wave 3 is not the shortest of Waves 1, 3, and 5.
  • Wave 3 is followed by a shallow Wave 4 correction. Therefore, Wave 4 has not retraced more than 100% of Wave 3, nor has it overlapped the end of Wave 1.
  • Wave 4 is followed by a minor push for Wave 5.As a result, the entire chart depicts a typical 5-wave structured motive wave.

Common Elliott Wave Crypto Trading Strategies

Elliott Wave theory essentially looks into a pattern of five consecutive waves before allowing traders to make a decision. The ideal way to begin an Elliott Wave count is to start at an extreme swing high or extreme swing low. According to Elliott Wave principles, the Elliott Wave count should typically be initiated from the end of the previous motive wave.

Having Wave 3 as the longest wave and Wave 5 as the same length as Wave 1 is a standard strategy used by traders during crypto trading. The bottoms of Wave 2 or Wave 4 are common trading spots due to the fact that they are easier to trade. Traders should also avoid the tops of Waves 3 and 5 since these are challenging areas.

Best practices for crypto trading using Elliott Waves

Elliott Waves can assist crypto traders in identifying the right crypto waves by following the three golden rules. The main issue, though, is that identifying and trading waves is easier said than done. Wave counting is a key aspect of identifying Elliott Wave patterns, especially waves 3 and 5. This is why, in addition to spotting wave patterns, crypto traders frequently combine price indicators such as moving averages and Fibonacci retracement levels. The Fibonacci retracement might help you figure out where Waves 2 and 4 (corrections) are likely to end.

Other techniques, such as candlestick patterns and fractals, can also help to make crypto trading easier by eliminating the need for guesswork in wave pattern analysis. They also assist traders in determining the best entry and exit points through rules-based strategies. As a consequence, crypto traders will be able to stick to a better trading strategy and have a smoother trading experience.

Elliott Waves in Crypto Trading: Conclusion

Elliott Waves are a great tool for crypto trading because they give a concise and comprehensive framework for analyzing market action. However, traders can make the most of it only if they have a more profound knowledge of analyzing Elliott Waves. Because cryptocurrency markets are more influenced by sentiment than any other financial market, crypto traders are advised not to rely exclusively on wave analysis. Instead, they can use moving averages, oscillators, and other indicators to help them decide whether to buy or sell Bitcoin or any other crypto asset. In addition, using a combination of wave theory and Fibonacci ratios to identify ideal entry and exit points for a trade is an excellent approach for traders to gain some additional insight.

Disclaimer: The content in this article comprises personal opinions and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. C-Trade, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness, of any information or data made available and assume no liability as to any loss arising from any investment based on the same.