Elliott Waves Theory – Channeling with Zigzags
Elliott Waves theory without channeling is not possible, and this tells much about the importance of channeling. Having said that, channeling it is mostly used in zigzags or zigzag family patterns. Technical analysis, in general, has many applications when it comes to channeling and such a concept has a great advantage: it is extremely visible. It means that, once a channel is drawn correctly, traders will have an easy time identifying places to go long or short. For example, a bullish trend is almost always having a channeling component, and traders will use any dips to add to an existing position or to enter a new trade. The same is valid in a bearish trend, when traders will look to buy when the price is reaching the higher edge of a channeling. With Elliott Waves, channeling refers to many patterns, but the overall concept is a bit different than how channeling it is being viewed in general. According to Elliott, there are specific rules about how to build a channel, namely where to start drawing a trend line and when it should end. Moreover, different patterns have different channeling components. For example, if in a double or triple zigzag, the channel must have two parallel lines, in a double or a triple combination parallelism is not mandatory. The same thing is valid in a double or a triple flat, where the two lines are rarely being parallel. Yet, the patterns are considered to channel.
Interpreting a Zigzag
Elliott Waves theory is a logical process, and this process is a sum of small things that lead to other things, those in turn lead to something else, and so on. If one thing is wrongly interpreted, chances are that the whole count will end up in a terrible loss. The same thing is valid when trying to interpret a zigzag, as the trader needs to follow a logical process. Here are two steps mandatory to follow to reach the right conclusion that should set the stage for the proper count.
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Expecting a Corrective Wave
It is primordial to know where you are with the count. It is mandatory at this stage to expect a corrective wave to form. Of course, that we will not know right from the start if the correction is a complex or a simple one, but we should at least be sure that a corrective wave is forming. To look for a corrective wave to form, it must be that market formed the following patterns prior to this correction:
- An impulsive wave of the same degree or a bigger degree ended
- The a-wave of a simple or complex correction ended
- The c-wave of a complex correction ended.
The next thing to do is to look at the nature of the first move to follow the three situations mentioned above. Remember what is the question to be asked all the time when trading with Elliott: is this move a corrective or an impulsive one? If the move is being interpreted as being an impulsive one, but, because of the previous logic, this impulsive wave should be part of a complex correction, it means we are looking for a possible zigzag to form. At this very moment, we don’t know if the zigzag is going to be a simple or a complex correction, and, we do have in front of us only the first five waves of this zigzag or the a-wave of the overall a-b-c that makes a zigzag pattern.
Using the Channeling Component
The channeling component is the one that offers the answer if the zigzag is going to be an independent structure, or it is going to be part of a complex correction. To be able to build the channel, we should wait for the b-wave to complete. How can we know for sure that the b-wave is completed? The thing to do is to wait for the price to move beyond the end of the previous a-wave in the zigzag, as that indicates the c-wave started. The next step is to draw a trend line from the start of the zigzag until the end of the b-wave (we must know exactly where that end comes!) and drag it forward on the right side of the chart. This way we have the upper side of the channel. If you copy that trend line and paste it from the end of the previous a-wave of the zigzag, a parallel channel will result. This is the channel that should tell us if the zigzag is a simple and independent correction or if it is part of a complex correction. The rule states that a zigzag as an independent pattern should not channel. That’s it! That means that, for the zigzag to be an independent pattern or a simple correction, the c-wave should either end well before the opposite trend line of the newly built channel or well after it. If that is the case, we will know for sure that the zigzag is a simple correction and by the time the c-wave (the c-wave in a zigzag is always an impulsive wave!) is completed, a trade in the opposite direction can be taken. On the other hand, if the c-wave ends around the opposite channel line, it means that the zigzag is part of a complex correction. Following the previous paragraph’s logical process, an x-wave should follow in that instance. Complex corrections are either having a small or a large x-wave. However, out of the two possibilities, small x-waves are most likely to form, and, if they are following a zigzag, they have the tendency to respect the channel. Therefore, by the time price is turning and reaches the other side of the channel, either through a sharp reversal or simply through consolidation, a trade in the same direction as the previous zigzag should be taken.
All these things are the result of correctly interpreting a zigzag and connect each step with the channeling component. Therefore, channeling has been used to identify the proper count, and not in the classical way as other technical analysis areas are using it.
This article shows once more that Elliott Waves theory is a complex one, even though the overall basic principle sounds so simple. As mentioned at the start of our part dedicated to Elliott, this is just an illusion.
Other educational materials
- What is Elliott Waves Theory?
- Defining Impulsive Waves
- Defining Corrective Waves
- Use the Fibonacci Extension Tool in Elliott Waves Theory
- Different Fibonacci Levels Important When Trading with Elliott
- Trading Different Types of Extended Waves
- Placing Pending Orders When Trading with Elliott
Recommended further readings
- Identification through technical analysis: A study of charting and non-professional investors. Roscoe, P., & Howorth, C. (2009). Accounting, Organizations and Society, 34(2), 206-221.