Elliot Wave Theory has been used by technical analysts to analyze and predict financial markets. Ralph Nelson Elliot, in the 30s, developed this theory based on the belief that market prices follow a repetitive wave pattern influenced in part by investor psychology. This theory can provide traders with insights into the market cycle and help them identify potential trends and turning points.
Elliot explains the Elliot Wave Structure. Price movements can be divided into two waves, impulse waves and corrective wave. Numbers (1,2,3,4,5) indicate the direction of the trend. Corrective waves (A-C) denote temporary price reversals.
Elliot believed waves of different sizes could be observed at different timeframes. Therefore, smaller wave patterns may exist within larger patterns. This fractal feature allows traders analyze price movements in various scales from short-term charts to longer-term trends.
Wave Relationships Elliot Wave Theory highlights the relationship among waves. Impulse waves follow corrective waves. Both the duration and the size of each wave are linked. Traders look at the ratios that exist between wave lengths and reversal/continuation areas.
Impulse Waves - Impulse waves are five-wave patterns that indicate the direction in which the trend is moving. Waves 1,3, and 5 move towards the trend. Waves 2 and 4, on the other hand, act as corrective wave. Fibonacci level retracement is a useful tool for traders to identify possible support and resistence areas within the impulse wave.
Corrective wave: These waves are also called ABC patterns and occur against a main trend. Wave A represents an initial correction. Then, wave B is partial reversal. Finally, wave C completes correction. Traders will often look out for pattern patterns within the corrective wave, like triangles or zigzags.
Elliot Wave Theory allows traders to approach market analysis in a systematic manner. Traders who can identify wave patterns and relationships between them will be able to make informed decisions for market entry and exit as well as risk management.
Wave Counting. Traders study price charts for wave characteristics and then label them. It's important to count correctly in order to make accurate predictions and analysis.
Wave Projections. Once wave counts are established, traders will be able to calculate future price targets using Fibonacci projections or extensions. These projections can be used to identify potential reversal regions or help set profit goals.
Elliot Wave is often used in conjunction with other chart patterns and technical indicators to confirm the count of waves. This could include moving averages or oscillators.
Elliot Wave Theory gives you a complete framework for forecasting market movements and understanding the dynamics of markets. By recognizing patterns of repetitive waves and their relationships traders can gain valuable information about market cycles, trend and potential turning points. Elliot Waves analysis should be combined with other trading techniques and a disciplined strategy.