The wolfe wave is a natural pattern that can be found in any market.
As a trader, you must know how to identify and analyze this chart pattern.
Having such knowledge will help you know how to predict the levels of demand and supply in the market.
In this article, I will be discussing everything that traders need to know about this chart formation.
Let’s start…
What Is a Wolf Wave?
A wolf wave is a price pattern made up of 5 wave patterns that signal an underlying equilibrium price and imbalances in the levels of demand and supply in the market.
Traders who use this chart pattern time their trades depending on the Support and Resistance lines indicated by the pattern.
The pattern may appear on all time frames from the 5-minute intraday chart to the weekly chart.
Unlike other chart formations, traders use wolfe waves to predict where the price is going, as well as the amount of time it will take to get there.
The pattern is a great tool for timing the market.
Just like with many types of “wave strategies”, the wolfe wave traders look for specific patterns where the security may experience a sudden change in value.
Once the first four “waves” have been formed, traders expect a new breakout to occur.
Consider the graphic given below…
The above graphic shows the formation of the bullish wolfe wave.
It is bullish because the final outcome/breakout occurs in a bullish direction.
As we have stated above, traders expect a new breakout to occur after the formation of the first 4 waves.
So, the pattern began by forming the first 4 waves.
The movement of these waves have been marked using the numbers 1 to 5.
What happened after that is a bullish breakout shown by the green arrow.
This makes it a bullish wolfe wave pattern.
Consider the graphic given below…
The above graphic shows the formation of a bearish wolf wave.
It is bearish because the final outcome/breakout occurs in a bearish direction.
The price action first formed the first 4 waves.
The movement of these waves have been marked using the numbers 1 to 5.
After the 4 waves were formed, a breakout occurred in a bearish direction.
This has been shown on the chart using a red arrow.
This makes it a bearish wolfe wave.
So, the question is…
What is the meaning of these reference points from 1 to 5?
Let me explain…
Point 1: The price wave patterns begin here and make an upward move to point 2 (bullish wave) or a downward move to point 2 (bearish wave).
Point 2: It is a peak (bullish wave) or a trough (bearish wave) of the wave pattern. It is higher than point 4 (bullish wave) or lower than point 4 (bearish wave).
Point 3: It is a retracement from point 2. It is higher than point 1 (bullish wave) or lower than point 1 (bearish wave).
Point 4: Is the second top from point 3 (bullish wave) or second bottom from point 3 (bearish wave).
Point 5: Represents a lower low (bullish wave) or a higher high (bearish wave) from point 4.
Good!
You know what each point in the pattern means
When traders draw a line between the 1st and 4th waves, they create a profit target line.
The line should be projected to the breakout point that is expected to occur after wave 5.
This helps the traders find the estimated price at arrival (future price) and the estimated time of arrival (when the future value will occur).
Consider the following graphic…
The above graphic shows how to draw the profit target line for a bullish wolfe wave.
The profit target line is the red line pointed to an arrow marked as Profit Target Line.
Note that the profit target line runs through the waves 1 and 4 and has been projected to the breakout point that is expected to occur after the wave 5.
Consider the following graphic…
The above graphic shows how to draw the Profit Target Line for a bearish wolf wave.
The profit target line is the green line pointed to by an arrow marked as Profit Target Line.
The profit target line passes through the waves 1 and 4 and has been projected to the breakout point that is expected to occur after wave 5.
As you will realize later, the profit target line and the price breakout may or may not intersect.
I will be showing you how to take your profits in both cases.
Keep reading…
Wolf Wave Trading Strategy Rules
As a trader, you must know the rules that govern the wolfe wave trading strategy.
The purpose of these rules is to determine whether the pattern is legitimate, or whether the pattern is just a product of random price oscillations.
Such knowledge will help you trade this chart pattern correctly, increasing your chances of making profit.
Note that the rules can be applied to both bullish and bearish waves.
The following are the wolfe wave’s characteristics…
- Wave 3 and wave 4 must be contained inside the channel created by waves 1 and 2.
- Wave 1 and wave 2 equals the waves 3 and 4, which should create a perfect symmetry.
- Wave 5 breaks above the trendline generated by wave 1 and wave 3 for a bearish wolfe wave. For a bullish wolfe wave, wave 5 breaks below the trendline generated by waves 1 and 3. Traders use wave 5 as an entry trigger.
- The time between all the waves is regular. This means that the time taken to complete one cycle, from low to low, is equal. So, between 1-3-5, the timing intervals between the wave cycles is equal.
It’s not a difficult task for you to identify a wolfe wave pattern.
Some trading platforms come with the wolfe wave indicator, making your work as a trader easier.
However, there are trading platforms that don’t come with this indicator.
In that case, you can use the channel indicator.
This will provide you with an easy way of visualizing the pattern.
How to Time your Entry and Exit Points using the Wolf Wave Pattern
The 5 alternating waves can generate a perfect channel or an ascending/descending wedge.
Sometimes, the waves may generate a flat channel.
The channel tells you about the price range within the market moves.
We can also create two trendlines starting from wave 1 to determine the entry and exit points.
Consider the graphic given below…
The above graphic demonstrates how to time your entry and exit when trading the bullish wolfe wave chart pattern.
First, the first 4 waves were formed.
A breakout then occurred in a bullish direction.
This is the best time for you to determine your entry point.
The green line running diagonally acts as the Support.
You can enter a long position once the bullish move breaks through this line.
This has been pointed to by a black arrow marked as Entry.
After the entry point, the bullish move continues until it hits the profit target line.
This is the red line running diagonally.
You can exit the trade after the bullish trend hits the profit target line.
This has been shown on the chart by the black arrow marked as Exit.
The wolfe wave chart pattern can be seen as an advanced channeling pattern.
A careful observation of this chart pattern will remind most traders about the falling and rising wedges chart pattern.
So, theoretically, this chart pattern is a variation of the falling wedge chart pattern.
Consider the figure given below…
The above figure shows the formation of the falling wedge chart pattern.
The red line running horizontally is the Resistance level.
The green line running horizontally is the Support level.
These two lines converge at a point on the lower part of the graphic.
The price action keeps on making high and low swings between the Support and Resistance levels.
Lastly, a breakout occurs in the bullish direction.
Traders can use this breakout to determine their entry and exit points.
The price action made many swings in between these two market structures before the occurrence of the bullish breakout.
When you compare the wolfe wave chart pattern and the falling wedging pattern, they look almost the same.
Hence, the wolfe wave chart pattern is a variation of the falling wedge chart pattern.
Now that you know how the chart pattern looks like, let me show you how you can use it to make money…
Best Wolf Wave Strategy-Bullish Wolfe Wave
When trading using this strategy, you will realize that once your entry is triggered, your position should show an immediate profit.
The reason is that the reversal pattern that emerges from this chart pattern is very violent.
After getting the first 5 waves, the general setup of the chart pattern will be ready.
Once the last wave breaks below the range channel, it’s time for you as a trader to get ready to take action.
Of course, the type of action to take can be to buy or to sell.
This will be determined by whether the pattern is bullish or bearish.
So, let me give you a step-by-step guide on how to trade this chart pattern…
#1: Before the Formation of a bullish wolfe wave chart pattern, look for a clear Bearish Trend
Yes, you must look for this.
Before the first wave is formed, a clear trend that needs to be reversed is formed.
For the case of high probability trades, you should see a bearish trend before the formation of the bullish trend.
Consider the chart given below…
The above chart shows the formation of a bearish trend before the formation of wolfe waves.
The bearish trend is shown by the red arrow moving downwards and marked as Bearish Trend.
After the bearish trend, a bullish trend follows.
The reason is that the bearish trend needs to be reversed.
This step is very critical for you to trade this chart pattern profitably.
Now that we have identified the trend, it’s time for us to apply wave rules on the chart.
So, we should proceed to the next step of our reversal strategy.
#2: Identify a 5 wave move that can be contained within a channel. The last wave, that is, wave 5, must break below the channel
Do you remember the wolfe wave rules that we discussed previously?
Certainly yes!
It’s now time to apply them.
For a wolfe wave pattern to be valid, it must have 5 waves that follow a number of simple rules.
The most important rules are that wave 3 and wave 4 must be contained within the channel that is created by wave 1 and wave 2.
Again, wave 5 must break below the trendline that is created by wave 1 and wave 3.
Consider the chart given below…
The above chart shows how the 5 waves of the pattern are formed.
After the initial bearish trend, a bullish trend followed, creating waves 1 and 2.
The price action then retraced, moving in a bearish direction.
This move created wave 3.
Again, the price retraced, beginning a new bullish direction.
This price move created wave 4.
The price retraced again, beginning a new bearish move.
This led to the creation of wave 5.
These moves created a 5 wave pattern on the chart!
The channel created by this 5 waves move has been marked by two black lines.
The chart pattern has met all the rules that we discussed previously.
The waves 3 and 4 are within the channel that was created by the waves 1 and 2.
Also, wave 5 breaks below the trendline that was created by waves 1 and 3.
This has been shown on the bottom part of the chart as the position where the final bearish trend breaks through the lower black line.
This means that the price action meets all the rules that must be satisfied for a wolf wave chart pattern to be considered valid.
It’s now time for us to lay down the entry strategy.
#3: Buy after the Break and Close inside the Price Channel
We want to enter a long position once the price enters and closes inside the price channel.
The reason for looking for a close inside is to eliminate possible fake breakouts.
Note that if we don’t find a close back into the price channel, there will be no valid trade signal.
Consider the following chart…
The above chart shows a break and close inside the channel.
The red candle inside the channel is an indication of a close inside the channel.
This candle has been shown using a red line marked as Closing Inside Channel.
This gives us a valid trade signal.
You should also look for how it quickly goes back into the channel.
You should only trade the pattern if it retraces quickly into the range.
It acts as a sign that a smart money reversal is at work.
Again, you should only trade the high probability trade setups.
The above chart depicts this strong characteristics.
From the chart, it’s very clear that after wave 5 broke below the channel, it reversed the very next day and closed above the price channel.
When trading this chart pattern, you must establish the position at which you will take profits.
I showed you, but we have to do it in our USD/INR chart!
So, let’s discuss it…
#4: Draw a Trendline to connect the wave 1 low and wave 4 high then extend it in the future. Take profits when it hits the EPA line.
This line connecting the low of wave 1 and the high of wave 4 is known as the wolfe wave EPA line.
EPA stands for Estimated Price at Arrival and is an effective strategy for take profit.
The main purpose of the EPA line is to show at what price the market will extend once it reverses the previous trend.
Consider the chart given below…
The above chart shows how to draw the EPA line and the position at which you should take profit.
The EPA line is the green line running diagonally on the chart.
The line begins from the low of wave 1 and passed through the high of wave 4.
The line has been extended to reach the point where it meets the bullish breakout.
That is how you should always draw the EPA line.
The take profit has been marked on the chart.
This is the point at which the bullish breakout hits the EPA line.
This has been pointed to by a black arrow marked as Take Profit on the chart.
In some cases, the EPA line may be too steep.
In that case, it may mean that the bullish breakout may never reach it.
This means that you may have to take profits early.
So, where do you place your stop loss when trading this chart formation?
Let me show you…
#5: Place a Stop Loss below Wave 5
You can place your stop loss order just below the wave 5.
This will protect your profits in case the bullish breakout reverses and begins to move in a bearish direction.
This strategy gives us a very tight stop loss, which is good for risk management.
A break below wave 5 means that we also break first below the channel.
But we will have invalidated the validity of the wolfe wave price pattern.
Consider the chart given below…
The above chart shows where to place your stop loss when trading this price pattern.
The position for the stop has been marked with a short red line running horizontally and marked as Stop Loss.
This position is just below the wave 5.
This stop loss will keep you protected in case the market begins to move against you.
If the price begins to move in a bearish direction, it will close your trade, protecting your profits from being wiped out.
Congratulations!
That was an example of a buy trade using the best wolfe wave strategy.
Let us now discuss how you can use the same strategy for a sell trade.
Best Wolf Wave Strategy-Bearish Wolfe Wave
To use this strategy for a sell trade, we have to follow the same steps that we followed for a buy trade but with some modifications.
Let’s discuss them…
#1: Before the Formation of a bearish wolfe wave chart pattern, look for a clear Bullish Trend
The bullish wolfe wave pattern was preceded by a bearish trend.
A bearish wolfe wave is different as it should be preceded by a bullish trend.
So, first look for a bullish trend that needs to be reversed.
The following chart demonstrates this…
The above chart shows the formation of a bullish trend prior to the formation of the bearish wolfe wave.
This has been shown by the black arrow marked as Bullish Trend.
Let’s see what next…
#2: Identify a 5 wave move that can be contained within a channel. Wave 5 must break above the channel
Consider the chart given below…
In the above chart, we have identified a 5 wave move that makes a valid wolfe wave pattern.
The waves 2 and 4 are contained within the channel created by the waves 1 and 3.
The wave 5 also breaks above the trendline that has been created by the waves 1 and 3.
This makes our chart pattern valid.
Note that in the bullish wolfe wave, wave 5 was breaking below the trendline created by waves 1 and 3.
In a bearish wolfe wave, wave 5 breaks above the same tredline.
#3: Sell after the Break and Close inside the Price Channel
You should sell once the price enters and closes inside the price channel.
A close inside the price channel will help you avoid fake breakouts.
Consider the following chart…
The above chart shows the price entering the price channel and closing inside it.
This gives you a valid trade signal.
It’s time for you to sell the currency pair as indicated on the chart.
Next…
#4: Draw a Trendline to connect the wave 1 high and wave 4 low then extend it in the future. Take profits when it hits the EPA line.
Consider the following chart…
The EPA line is the green line running horizontally on the chart.
The line starts from the high of wave 1 and passes through the low of wave 4.
The position at which this line cuts through the bearish breakout marks your take profit point.
This has been pointed by a green arrow marked as Take Profit.
Note that in the bullish wolfe wave, the EPA line was running from the low of wave 1 through the high of wave 4.
In a bearish wolfe wave, the EPA line is running from the high of wave 1 through the low of wave 4.
#5: Place a Stop Loss above Wave 5
The price can go against you.
So, a stop loss is necessary.
Consider the following chart…
The above chart shows where to place the stop loss order when using the best wolfe wave strategy for a sell trade.
This has been shown using a red line marked as Stop Loss.
The position of the stop loss as shown above is just above the wave 5.
If the market reverses and begins to go contrary to your trade, the stop loss will close the trade.
This will save you from making a loss.
In the bullish wolfe wave, the stop loss was placed below wave 5.
In a bearish wolfe wave, the stop loss has been placed above wave 5.
Congratulations!
That’s how you can perform a sell trade using the best wolfe wave strategy!
Conclusion:
This is what you’ve learned…
- The wolfe wave trading strategy is built around waves just like the Elliot Wave trading strategy.
- To find possible trading signals, we use concepts like price symmetry and channeling.
- The chart pattern gives traders a tight stop loss.
- This is good for risk management.
- The bullish wolfe wave chart pattern is preceded by a bearish price move.
- The bearish wolfe wave chart pattern is preceded by a bullish price move.
- The trendline drawn from the wave 2 to the wave 4 must be contained within the channel created by the waves 1 and 3.
- For a bullish wolfe wave chart pattern, the wave 5 must break below the trendline running from wave 1 through wave 3.
- For a bearish wolfe wave chart pattern, the wave 5 must break above the trendline running from wave 1 through wave 3.
- The best time to trade the chart pattern is when the wave 5 breaks and closes inside the price channel.
- For a bullish wolfe wave chart pattern, place your stop loss order just below wave 5.
- For a bearish wolfe wave chart pattern, place the stop loss order just above wave 5.