Markets move in waves. 5 waves in one direction and then 3 waves in the opposite direction on any timeframe and in both up and down sequences.
The correction is called an ABC sequence and if correctly identified, the market then moves into a new 5 wave up sequence. This has long been established through the Elliot wave theory (EW).
DeMark waves (TD-waves) differ from EW as they use set mechanic rules for the waves. This sometimes leads to us seeing markets in a different stage than EW commentators.
TD waves also stay silent in non-trending markets which is the most common stage. For more information and explanation about Elliot, waves click here
The rules regarding TD Waves are as follows:
First TD-waves only consider the closes rather than high and lows. This means highs and lows can eclipse the extremes of the prior waves (not allowed in EW but making it a better tool).
To identify a wave (for an uptrend):
Wait for the market to Close above all 21 previous Closes. Then wave 1 up is locked in.
When wave A is in, wait for the market to close below all 8 previous closes (rolling) to lock in wave 2 low. This is often the most important spot to act on as most are fooled here and expect the markets to return to the previous downtrend.
Instead, the markets move to a close higher than all 21 previous triggering wave 3 up. The third wave is the most important to catch as it is supposed to be impulsive- that is to move without overlapping.
The market remains in wave 3 until a close below all 13 previous closes. With that, wave 3 is over and wave 4 has begun. This is often the trickiest phase with overlaps and false starts.
Following wave 4 low the market then moves higher and closes above all 34 previous closes, often a new high, and wave 5 triggers. From here on, stops must be used as they could end at any time.
Wave 5 ends when a close below the previous 13 closes to record the A-wave low, the first leg of a correction lower.
Wave B records when there is a close above all previous 8 closes. This wave B high Wave 2 as Wave C like wave 3 should be impulsive.
Wave C also has to be below wave A so the minimum move lower is known. With a new low close below wave A close, the C-wave is locked in and the new count can begin.
Important to note, unlike EW, the DeMark TD waves can shift back to the previous count. This is important as one can not view the waves as subjective. For example, wave A and B are in but the market moves back to a new high, and such moves back into wave 5 up.
When the C-wave low is in, it is very important to figure out what market structure it is in, as it could turn into Wave 3 down and is therefore important to catch. In that case, a bounce is only wave 4 high and will be followed by a wave 5 down.
The rules for determining the different projections for the lengths of the waves are as follows:
Wave projections are derived from Fibonacci numbers 0.618 and 0.38.
After wave 1 concludes
Wave 2 is either 38% or 61% of the length of Wave 1
Wave 3 is 1.618 of Wave 1 Added to Wave 1 low Close
Wave 4 is 38% or 61% of Wave 3 and if Wave 2 is deep, 61.8% then Wave 4 should be shallow 38%.
Wave 5 is 1.618 of wave 3 added to the low of wave 3.
A projection for Wave 5 from the Wave 1 is also done where wave 5 is projected to be Wave 1 * 1.382 from the Wave 2 low.
If wave 3 is long and goes beyond its projection then Wave5 is expected to move 2.23 times the wave 1.