Elliott Wave Theory | Trading Market Trend Reversal Signals

Market Trend Reversal Signals

Some say that Price Reversals can be brutal and sudden because when an existing mature trend is in place, it can catch complacent traders off guard. Trend Reversal trades are notoriously hard to spot in the early stages as at first, they are simply in a pullback phase and it’s only when the pullback breaks a few elliott wave theory rules then it becomes a potential Market Trend Reversal Signals trade.

For me, Swing trading a potential Elliott Wave Theory Market Trend Reversal Signal is the only way and only on a Daily or even Weekly time-frame for longer term trades. Every trader has their own set of rules and strategies for Trend Reversal and I am no different.  I prefer to understand the previous, mature, trend and its behaviour within Elliott Wave theory basic principles. So, looking at the whole of previous mature trend the following must be present before I move onto my real analysis. (this is the case for both Bullish and Bearish Trends):

  1. The Wave 2 cannot retrace more than 100% of Wave 1
  2. Wave 3 can never be the shortest of the 3 impulse waves
  3. Wave 4 can never overlap Wave 1.

images of elliott wave theory rules

Further observations that can be made to help understand if the mature trend is closing in on the final wave 5. In most cases when the wave 3 was the strongest and longest of the impulse waves then the 5th Wave is approximately the same length as Wave 1.  This is helpful, when combined with previous support and resistance levels, together with a fall in daily volume to establish a high probability price zone for the Wave 5 to end and start a pull back against the mature trend.

There are 8 main trading indicators that I use to establish a potential market trend reversal signals trade and entry strategy. I will cover those over the next few pages, before the two examples I have of real Trend Reversal trades that I have carried out, taken from my trading journals.  I prefer 7 out 8 indicators mentioned, to be “in the green” before entering a trade.  There is lots more to my strategy that can be picked up in the trading journal entries to follow the indicator explanations.

Ellioitt Wave Theory Oscillator Divergence

First let me explain what an Oscillator is and what parameters I use, as the Oscillator is used in two of my 8 indicator criteria. An Oscillator is a picture of two extreme values using vertical lines that look like a very busy histogram. The extreme values measured in this case are two Moving Averages and so as not to clutter up your chart the Oscillator Indicator gives that graphical representation of the gap between the two moving averages.

As you can see from the chart to the right the top yellow Moving Average is a 5 Day Moving Average and the lower is a 35 Day Moving Average.  These are my settings for Daily Charts. So, when setting the Oscillator, I look to set for 5 and 35 Day Exponential Moving Averages (on a Weekly Chart look for 10, 70).  The Oscillator at the foot of the chart is just a graphical representation of the gap/space between the two moving averages.

image of chart showing how 5 and 35 oscillator works

Back to Oscillator Divergence to help with identifying Market Trend Reversal Signals

When the Wave 5 makes new Highs or Lows, the Oscillator should show divergence between the peaks of Wave 3 and Wave 5 as sown on the example below.  Not forgetting another Elliott Wave observation that the 5th Wave is less intense than that of the Wave 3, so the Oscillator height should be smaller.  If this is not the case, then obviously, the intensity of Wave 5 is high and the potential for a trend reversal is low. As you can see the line connecting the Wave 3 and 5 on the Chart is divergent to that of the line connecting the peaks of the same waves on the Oscillator.

images of chart showing wlliott wave oscillator divergence

Oscillator Elliott Wave 4 Measurement.

As previously stated a great deal of the work carried out using these 8 indicators is measuring the performance of the previous mature trade and how the Wave 4 profit taking pull back behaved.  This next use of the same Oscillator as above and exactly as in the “With Trend” Strategy, in that the Oscillator, should pull back between 90% and 140% of the Wave 3 at its longest point, as below. This gives more probability that this wave pattern is on course to complete a Wave 5, then look to pull back from there as either a correction or Market Trend Reversal Signals.

See How I used this Elliott Wave Theory Market Trend Reversal Signals Strategy in two comprensive Trading Journals in my Free Ebook HERE

images of chart showing Wave 4 Pull Back Fibonacci Measurement

Wave 4 Pull Back Fibonacci Measurement

On the same theme as before, another indicator/measurement that is vital to understanding the Wave 4 Pull back is to measure a Fibonacci retracement of the Wave 3. The Elliott Wave Theory Wave 4 Pull Back should be greater than 0.25 but less than 0.618. As you can see from the example below, the Wave 4 back ended between the 0.25 and 0.382 line, which incidentally gives an 85% probability of the mature trend continuing to make a new low in this case.

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