The Wolfe Wave is a chart pattern consisting of five waves that predict the trend reversal in the market. It is the most underrated chart pattern, but it offers high-risk reward trades with high accuracy.
Most professional traders use the Wolfe wave pattern for long-term forecasting and then trade in the predicted direction on lower timeframes. It is the advanced strategy used by traders.
This pattern can be used in stocks, indices, and forex.
How to identify Wolfe wave pattern?
Bill Wolfe was a professional trader who introduced the Wolfe wave. He said that it is a natural pattern that will work in every market.
To identify this pattern on the chart, you should follow the following rules.
Wolfe wave rules
- Rule #1: Wave 1 and 2 create a price channel that must contain wave 3 and wave 4. So, waves 3 & 4 must remain within the channel.
- Rule #2: Wave 1 should be equal to or greater than wave 3.
- Rule #3: The interval between waves 1 to 2 and waves 3 to 4 should be approximately equal.
- Rule #4: The final wave 5 should break the channel representing a breakout and then close within the channel later.
Bullish Wolfe Wave
A descending channel will form in the bullish pattern, containing 4 waves of Wolfe pattern. Price will make consecutive lower lows and lower highs, showing a downtrend.
After channel breakout, the 5th wave will form.
Bearish Wolfe Wave
In the bearish pattern, an ascending channel will form, which will contain the waves. Price will make consecutive higher highs and higher lows, indicating an uptrend.
After the breakout, a bearish trend will start in the 5th wave.
What does the Wolfe wave pattern tell traders?
There is symmetry in the Wolfe wave pattern, and it always repeats on the price chart. It shows the natural behavior that shows it will work in every market of the world for technical analysis purposes.
The psychology tells traders that a trend reversal is about to occur after three attempts and a breakout. The price always moves in the form of waves (ups and downs).
For example, in the bullish Wolfe wave, the price makes three lower lows, showing that the market is now in oversold conditions and now a bullish trend will start. A breakout of the channel in a downward direction shows the break of a critical level and filling of buy orders of institutions. This is also a factor for bullish trend reversal.
How to measure the target level of the Wolfe wave?
Connect the starting point of wave 1 to the starting point of wave 4 and then extend the line until it meets the price at some point.
A similar method is followed for both bullish and bearish patterns.
There is no fixed target or take profit level in the Wolfe wave. Because it will change, it will offer huge risk-reward ratios in some patterns, but some patterns will not. So, it is recommended to trade the patterns that give a high-risk reward.
Wolfe Wave trading strategy
Here I will explain the Wolfe wave strategy with an example.
The first step is to determine the higher timeframe trend. You can do this by simply marking the higher highs or lower lows. This will help you to trade only in the direction of the trend.
In the next step, apply the rules and identify the pattern on the chart. As in the example, it shows a trend reversal in the direction of a higher timeframe trend. Let’s support that we would skip this trade setup if it were against the primary trend.
The third important step is entry. When the price breaks, wait for the price to close again within the channel. Open a buy trade when the price closes within the channel. Measure the target levels and place stop loss below the last low made by price.
It is a simple strategy to trade with the trend.
Like the Elliott wave, the Wolfe wave is the best way to forecast and trade the market. This pattern is not popular among traders, but it has a high winning ratio and risk-reward.