A Quick Dive Into The Field of Elliot Wave Analysis – Introduction
On a single day, millions of people from around the world struggle to make decisions about financial assets. Their struggle is on how to predict the direction in which the securities will move. When their price moves higher, they profit by buying the securities. If they believe that the price of the securities will move lower, they sell short. To do all this, the traders use a number of strategies. The first common strategy is on fundamental analysis. In this, they consider the relevant news and how they will impact the market. For example, if the Federal Reserve releases a dovish statement, they sell the dollars and vice versa.
The other common strategy is on technical analysis. In it, the traders use one or a combination of the technical indicators that are provided by the brokers. These indicators include tools like the moving averages, relative strength index, relative vigor index, and the stochastics. They then combine these tools with the charting tools, which include tools like Fibonacci Retracement, Ghost Feed, Gann Fan, and Pitchfork to predict where the prices will move. This article will focus on another common charting tools that investors use to make decisions on trading. This tool is known as the Elliot Wave, which was developed by Ralph Eliot Elliot in 1930s.
In his theory, Ralph said that he believed that the stock market tended to move in certain patterns. He proposed that if traders took time to look at the patterns, they would be more successful. It was also similar to the Dow theory that recognized that stocks used to move in waves. Ralph was able to look at the Dow theory and break it up in greater details. Broadly, the Dow theory is summarized below.
In this, when the price of a security is moving up, Ralph theorized that it does so in five major steps. In the chart above, the first five steps are known as the impulse wave. For it to be a good Elliot Wave, wave 1, 3, and 5 are usually bullish while wave 4 and 3 are known as reactive. In this, the third wave is usually the longest part of the wave.
After the impulse wave is formed, the price tends to form another cycle that is known as the corrective wave. This is usually formed by three waves, which are often labeled as A, B, and C. A summary of the Elliot Wave is shown in the chart below.
For this wave to happen, there are a number of rules. First, the asset needs to be in a trend. This means that it is impossible to apply the Elliot Wave when the security is in consolidation mode. Second, wave 2 can never retrace 100% of the first wave. Third, the third wave is usually the longest. Fourth, wave 4 may never end in the price zone of wave 1. A violation of any of these rules cancels out the effectiveness of the Elliot wave.
To be clear, while the Elliot Wave has been applied successfully over the years, it has some critics, who argue that it is based on theories that don’t work. Even for you, to use it well you need to take a lot of time to perfect the art the art of the analysis.