By: Andrei Tratseuski and Kai Hui CaiWolfe Waves were developed by Bill Wolfe and are similar to the Elliot Wave principle in its approach (which will be covered an upcoming article).
Unlike the Elliot Wave, which works best in trending markets, the Wolf Wave works best in stable markets with some volatility. The Wolfe Wave also closely resembles the pennant or ascending triangles in its shape, although it works after the ascending triangle or pennant reaches its maximum profitability.
Wolfe's theory of wave structure is based on Newton's first law of physics: for every action there is an equal and opposite reaction. This movement creates a definite wave with valuable projecting capabilities.
These waves most clearly set up when there is good volatility. These patterns can develop over short and long-term time frames such as minutes or weeks.
Wolfe Wave uses five different points for determining its outcome. The key to its accuracy is in properly identifying points one through five. For a buy setup, we begin the count at a top.
ß Number 2 wave is a top.
ß Number 3 wave is the bottom of a first decline.
ß Point 1 is the bottom prior to wave 2 (top).
ß Point 3 must be lower than point 1.
ß Point 4 is the top of wave 3. The point 4 should be higher than the wave 1 bottom.
ß A trend line is drawn from point 1 to point 3. The extension of this line projects to the anticipated reversal point which we will call wave 5. This is the entry point for a ride to the apex line (1 to 4).
ß The Estimated Price at Arrival (EPA) is the trend line drawn from points 1 to 4. This projects the anticipated price objective. Our initial stop is placed just beneath the newly formed reversal at point 5.
ß Estimated Time of Arrival (ETA) is apex of extended trend line of 1 to 3 and 2 to 4.
ß The EPA and ETA should be approximately vertically lined up.
You cannot begin looking for the Wolfe Wave until points 1, 2, 3 and 4 have been formed. Keep in mind that for a buy, point 3 must be lower than point 1 and point 4 will be higher than point 1. You must also keep in mind that wave 5 must be higher or lower than all of the other waves, depending on whether it is bullish or bearish, respectfully.
This strategy can maximize your returns on long-term basis. Although this strategy would not be found in many traditional technical analysis books, it does possess very powerful potential. Keep in mind that this strategy is not for the short-term. It will most likely not work under day-trading timeframes, but will work well on daily intervals. Be patient when using this strategy. A great man once stated "Patience is a virtue."