What is Elliott Wave ?
Elliott Wave theory is one of the most acknowledged and widely used forms of technical analysis. RN Elliott developed the theory after analyzing nearly 75 years of stock data, and Robert Prechter later popularized it.
According to the Wave theory, the market trades in repetitive cycles, which Elliot primarily attributed to the emotions of investors (or the psychology of the masses at the time) as well as outside influences.
Why it is appealing?
The Elliot Wave theory proves that the upward and downward price swings caused by the collective psychology always reflect the same repetitive patterns.
Elliot observed that all financial markets move in a zigzag formation, which he termed Wave cycles. With this theory, Elliot was able to analyze markets in greater depth by identifying the specific characteristics of wave patterns and was able to make detailed market predictions based on these patterns.
This is what makes the Elliott Wave theory so appealing to traders as it provides them with a method to spot precise price points where the market is likely to reverse.
In simpler words, Elliott came up with a system that enables traders to catch tops and bottoms.
Basic Principals of the Theory
The Elliott Wave theory states that the market is fractal in nature i.e. it forms the same patterns that are observed on larger degree charts on smaller timeframe as well, and that it can be used to predict future price movement. The theory states that it does not depend on the timeframe one analyzes as a similar price pattern is observed across all time frames.
The theory claims that that market action among the participants produces wave patterns and trends, defined by Elliott as the physical sign of mass psychology.
The complete cycle of the Elliot Wave development consists of eight waves that make up two phases:
An impulse wave sub-divided into five waves and,
A corrective wave sub-divided into three waves
Price movement
According to the theory, price movement in the direction of the main trend is defined as the impulse or motive phase, which unfolds in five waves. Three of those waves (1, 3, and 5) move in the direction of the underlying trend, while the two intervening waves (2 and 4) act as counter-trends or minor retracements within the phase.
Wave 5’s up move is followed by a correction 3, which traders usually label as A, B, and C. The 5-3 wave pattern can be seen across all timeframes.
The corrective phase consists of two waves (A and C) that move in the opposite direction of the motive phase, and an intervening retracement wave (B) that moves in the same direction of the motive phase.
The 5-3 wave pattern establishes a complete Elliot wave cycle. The theory tends to get more complicated as more degrees of waves get added. The key to using the Elliot wave successfully lies in counting the waves correctly and identifying the wave in which the market is currently trading in.
Rules of Elliot Wave Theory
There are three main rules to the Elliot Wave theory that analysts must know. These rules apply only to the impulse phase
First rule: Wave 2 cannot retrace more than 100% of Wave 1 i.e Low of wave 2 must not touch or break wave 1's Low.
Second rule: Wave 3 cannot be the shortest among waves 1, 3, and 5
Third rule: Waves 1 and Wave 4 must not overlap i.e Wave 4's bottom must not break the high of wave 1.
Guidelines
There are numerous guidelines to this theory, but we will take a look at the most prominent ones. Unlike the three cardinal rules, these guidelines can be broken.
They are:
Guideline 1: When Wave 3 is the longest impulse wave, Wave 5 will approximately equal Wave 1 as shown in the figure above by highlighting about 8000pts.
Guideline 2: The forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp correction, then Wave 4 will be a flat correction . If Wave 2 is flat, then Wave 4 will be sharp .
Guideline 3: Sometimes, Wave 5 does not move beyond the end of Wave 3. This is known as truncation.
Guideline 4: After a 5-wave impulse advance, corrections (a-b-c) usually end in the area of prior Wave 4 low i.e may be near 30000
Guideline 5: Wave 3 tends to be very long, sharp , and extended.
Guideline 6: Waves 2 and 4 frequently bounce off Fibonacci retracement levels.
Elliott Wave theory is one of the most acknowledged and widely used forms of technical analysis. RN Elliott developed the theory after analyzing nearly 75 years of stock data, and Robert Prechter later popularized it.
According to the Wave theory, the market trades in repetitive cycles, which Elliot primarily attributed to the emotions of investors (or the psychology of the masses at the time) as well as outside influences.
Why it is appealing?
The Elliot Wave theory proves that the upward and downward price swings caused by the collective psychology always reflect the same repetitive patterns.
Elliot observed that all financial markets move in a zigzag formation, which he termed Wave cycles. With this theory, Elliot was able to analyze markets in greater depth by identifying the specific characteristics of wave patterns and was able to make detailed market predictions based on these patterns.
This is what makes the Elliott Wave theory so appealing to traders as it provides them with a method to spot precise price points where the market is likely to reverse.
In simpler words, Elliott came up with a system that enables traders to catch tops and bottoms.
Basic Principals of the Theory
The Elliott Wave theory states that the market is fractal in nature i.e. it forms the same patterns that are observed on larger degree charts on smaller timeframe as well, and that it can be used to predict future price movement. The theory states that it does not depend on the timeframe one analyzes as a similar price pattern is observed across all time frames.
The theory claims that that market action among the participants produces wave patterns and trends, defined by Elliott as the physical sign of mass psychology.
The complete cycle of the Elliot Wave development consists of eight waves that make up two phases:
An impulse wave sub-divided into five waves and,
A corrective wave sub-divided into three waves
Price movement
According to the theory, price movement in the direction of the main trend is defined as the impulse or motive phase, which unfolds in five waves. Three of those waves (1, 3, and 5) move in the direction of the underlying trend, while the two intervening waves (2 and 4) act as counter-trends or minor retracements within the phase.
Wave 5’s up move is followed by a correction 3, which traders usually label as A, B, and C. The 5-3 wave pattern can be seen across all timeframes.
The corrective phase consists of two waves (A and C) that move in the opposite direction of the motive phase, and an intervening retracement wave (B) that moves in the same direction of the motive phase.
The 5-3 wave pattern establishes a complete Elliot wave cycle. The theory tends to get more complicated as more degrees of waves get added. The key to using the Elliot wave successfully lies in counting the waves correctly and identifying the wave in which the market is currently trading in.
Rules of Elliot Wave Theory
There are three main rules to the Elliot Wave theory that analysts must know. These rules apply only to the impulse phase
First rule: Wave 2 cannot retrace more than 100% of Wave 1 i.e Low of wave 2 must not touch or break wave 1's Low.
Second rule: Wave 3 cannot be the shortest among waves 1, 3, and 5
Third rule: Waves 1 and Wave 4 must not overlap i.e Wave 4's bottom must not break the high of wave 1.
Guidelines
There are numerous guidelines to this theory, but we will take a look at the most prominent ones. Unlike the three cardinal rules, these guidelines can be broken.
They are:
Guideline 1: When Wave 3 is the longest impulse wave, Wave 5 will approximately equal Wave 1 as shown in the figure above by highlighting about 8000pts.
Guideline 2: The forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp correction, then Wave 4 will be a flat correction . If Wave 2 is flat, then Wave 4 will be sharp .
Guideline 3: Sometimes, Wave 5 does not move beyond the end of Wave 3. This is known as truncation.
Guideline 4: After a 5-wave impulse advance, corrections (a-b-c) usually end in the area of prior Wave 4 low i.e may be near 30000
Guideline 5: Wave 3 tends to be very long, sharp , and extended.
Guideline 6: Waves 2 and 4 frequently bounce off Fibonacci retracement levels.