Elliot wave theory
Elliot wave is a type of technical analysis that some traders use to analyze market cycles and forecast market trends by identifying extremes in investor psychology (greed/fear). Ralph Nelson Elliott (1871–1948), a professional accountant, developed the analytical tools in the 1930s. He proposed that market prices unfold in specific patterns called elliot waves. The elliot wave consist of 8 wave counts. Wave 1 to 5 are in an impulsive phases while wave 6, 7, 8 or a, b, c are in a corrective phase. As seen in the first picture wave 2 and 4 are corrective waves in the impulsive phase. Wave c is an impulsive wave in a corrective phase.
Elliot waves can also be seen on a downtrend, look at the third picture for an illustration on this. The theory is that each wave can be broken down into smaller elliot waves, and these waves repeat over and over again until the underlying force that caused the impulse goes away. The basic rules are that wave 2 cannot exceed the low of wave 1 and wave 4 cannot overlap wave 1. Check the second picture for an illustration on this.
If the waves doesn't fit the guide lines it's not considered an elliot wave. One model of the elliot wave states that wave 2 is a 50% to 60% retracement of wave 1. Wave 3 is 1.618 times the length of wave 1, and is the longest wave. Wave 4 can be any be anything between 10 to 20% retracement of wave 3. Wave 5 is the same length as wave 1. Elliot wave is actually quite common on multiple time frames. However, they aren't always perfect as they tend to get skewed by mixed news and market manipulation. The driving forces that causes such impulses is not always sustained throughout the period.
I am a big believer of psychology in price action. However, as much I like the elliot theory analysis, I also don't like it because it draw lines on the chart that do not exist, and forecast specific prices. What I try to get out of this theory is the psychology and the meaning behind his theory. I believe elliot wave theory should be part of your trading arsenal, but don't get too caught up and be too strict with the numbers.
Elliot waves can also be seen on a downtrend, look at the third picture for an illustration on this. The theory is that each wave can be broken down into smaller elliot waves, and these waves repeat over and over again until the underlying force that caused the impulse goes away. The basic rules are that wave 2 cannot exceed the low of wave 1 and wave 4 cannot overlap wave 1. Check the second picture for an illustration on this.
If the waves doesn't fit the guide lines it's not considered an elliot wave. One model of the elliot wave states that wave 2 is a 50% to 60% retracement of wave 1. Wave 3 is 1.618 times the length of wave 1, and is the longest wave. Wave 4 can be any be anything between 10 to 20% retracement of wave 3. Wave 5 is the same length as wave 1. Elliot wave is actually quite common on multiple time frames. However, they aren't always perfect as they tend to get skewed by mixed news and market manipulation. The driving forces that causes such impulses is not always sustained throughout the period.
I am a big believer of psychology in price action. However, as much I like the elliot theory analysis, I also don't like it because it draw lines on the chart that do not exist, and forecast specific prices. What I try to get out of this theory is the psychology and the meaning behind his theory. I believe elliot wave theory should be part of your trading arsenal, but don't get too caught up and be too strict with the numbers.