How Momentum Indicator (RSI) is Used with Elliott Wave

  • Wave 3 in Elliott Wave Theory typically is the strongest wave. In a bullish market, RSI of wave 3 often continues to stay at an overbought region (>70). A traditional understanding of RSI suggests if RSI is over 70, it is overbought and thus traders might sell it. However, we do not recommend selling wave 3. In fact, an extended period of RSI above 70 signals that the trend is in that direction and thus it’s better to buy the dips rather than trying to pick the top and sell.
  • Wave 5 in Elliott Wave Theory typically comes with momentum divergence. In a bullish market, this means price makes a higher high while momentum (RSI) makes a lower high. With the traditional understanding, momentum divergence suggests it’s bearish and instrument can selloff. In our view however, a momentum divergence in an uptrend suggests the prevailing trend is bullish as divergence occurs in wave 5 and a 5 waves structure defines the trend’s direction. Thus, even though instrument can do 3 waves pullback after the end of wave 5, if the prevailing trend is bullish, it’s better to buy the dips rather than picking the top and selling wave 5.
  • A divergence also happens in the fifth swing of a 7 swing structure. A 7 swing structure is called a double correction or WXY. Sometimes people call it a double zigzag if the internal of wave W and Y happen to be both a zigzag. In a 7 swing double three structure, the fifth swing should come with a divergence like the graph below shows:

Double Three Structure

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Elliott Wave Forecast

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