Elliot Waves

The Elliot wave theory was created in the late 1920's by Ralph Nelson Elliot. After discovering the existence of a repetitive and cyclic behavior in the stock markets that were formerly considered to be random and chaotic in natures, he realized a behavior that depends on the reactions of investors at a particular moment. He then understood that this was the result of mass psychology.

Elliot continued to study the structure of those repetitive patterns that show up as waves within waves and can repeat themselves indefinitely. This showed two specific characteristics, impulse and correction, and he then applied this to market prediction. Thus, the Elliot wave theory was developed and has been used ever since.

Interpretation of Elliot Waves

When looking at the Elliot wave theory you will need to understand how it is meant to be interpreted. The following points is how the Elliot waves are interpreted by forex traders.

  • Every action is followed by a reaction.
  • Five impulsive waves move in the direction of the main trend and are followed by three corrective waves (a 5-3 move).
  • A 5-3 move signals completion of a cycle.
  • This 5-3 move then becomes two subdivisions of the next higher 5-3 wave.
  • The underlying 5-3 pattern remains constant, independent of the time scale you are using.

The Elliot wave theory assigns a series of categories to the waves going from largest to smallest. The categories are listed as grand supercycle, supercycle, cycle, primary, intermediate, minor, minute, minuette, and subminuette. Each of these are used when using the Elliot waves for analyzing your forex trading.

Elliot Wave Analysis

The Elliot wave theory is a form of technical analysis used by many traders today. It helps traders analyze market cycles and forecast trends going on in the market. This form of technical analysis also has relations to the Fibonacci numbers, which is another popular form of technical analysis. These are two of the most famous ways of performing technical analysis in the forex market.

If you are going to perform a correct Elliot wave count you must observe 3 rules:

  1. Wave 2 always retraces less than 100% of wave 1
  2. Wave 3 cannot be the shortest of the three impulse waves, most of the time waves 1, 3 and 5
  3. Wave 4 does not overlap with the price territory of wave 1, except in the rare case of a diagonal triangle.

Be sure to find a good study on how to accurately read the Elliot waves because if read incorrectly it can cost you. Many of the good forex training programs out there will provide good information and study guides on how to use the Elliot wave theory in your technical analysis. Using a program like this is a great idea for someone just entering into the market for the first time.

Also remember, the Elliot Waves are a theory and will not make every trade that you make the right one. Just like with any technical or fundamental indicator, you need to remember that the market is never 100% predictable. There are things that you can do to help make the best decisions, such as use Elliot waves, but they never guarantee anything.