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What is Elliot Wave in Technical Analysis?

BitForex Editor
Nov 06, 2020

When technical analysis is mentioned regarding finances, we know it is a method used to forecast the trajectory of stock prices using information obtained by studying past market data. Even though stock prices are affected by the slightest of factors, making it somewhat unpredictable. Technical analysis has shown that it is particularly useful in predicting stock prices with impressive results.

Elliot Wave Theory

The Elliot wave theory is a theory that has been of tremendous importance to people looking to invest in the stock market. Before this theory was propounded, people actively believed the Efficient-market hypothesis (EMH), which explained that the stock market is only affected by new information and is not affected by past data. It went further to state that the stock market was unpredictable and almost impossible to beat the market with regularity.

Many people have debunked many of these claims made by this hypothesis—the most notable of them being Warren Buffet. One of the earliest people to counter this hypothesis is Ralph Nelson Elliot, who suggested that the stock market prices unfold following specific wave patterns. These waves can be seen in the behaviors of customers and the movement of stock prices. This theory encourages the studying of past market data to look for recurring price patterns.

How Does The Elliot Wave Theory Was Formed

Ralph Nelson Elliot, who used to work as an accountant before his forced retirement due to an illness, propounded this principle. To beat the boredom caused by his unfortunate early retirement, Elliot decided to study 75years worth of market charts across various indexes. After doing this, he was able to establish wave patterns in which prices can be predicted using. This lead to him publishing books where he provided all the information everyone would need to predict, identify, and take advantage of the wave patterns. These rules and guidelines are now used by the most significant market forecasting firm Elliot Wave International. This firm bases its market forecasts on the Elliot wave principle, and it has been very effective as it has posted extremely successful market forecasts.

The Elliot wave theory was postulated in the 1930s and shot into the limelight when Elliot accurately predicted the stock market's lowest price would be traded. This made every trader embrace his theory.

Elliot Wave Analysis

Technical analysis is a prevalent method used by traders to make their trading decisions. These technical analyses involve using complex mathematical equations to identify the trends or patterns in the market. Traders employ the use of indicators to make their decisions in the market. One such indicator is the Elliot wave (EW). This indicator has gained so much popularity that it had its niche in the analysis of forex.

To enjoy success using this indicator, you need to understand it and know how to apply it in different circumstances. This article will explain to you all you need to know about Elliot wave.

One important thing to know about Elliot wave is that it does not use complex mathematical equations, as seen with technical analysis. Instead, it uses market data from the past to observe patterns and trends in the financial market as the theory believes that certain behaviors of the financial market will reoccur in the present and future. Prices in the forex and financial markets are always experiencing fluctuations. They go up and down. This up and down movement of prices is what Elliot described as waves, which is where it got its name, Elliot Waves, as Elliot first described waves. The study of these waves to make trading decisions is referred to as Elliot wave analysis or Forex Wave analysis.

In Elliot wave analysis, prices in markets move in a 5-3 sequence or wave pattern. The first five waves are called impulse waves and are labeled using numbers one to five (1-2-3-4-5), while the corrective waves, which are the last three waves, are labeled a-b-c.

Impulse Waves

The impulse waves are labeled using numbers 1-5, and they give different information about the investor.

Wave 1

In this Wave, prices are low, and investors will consider it a cheap or oversold market.

Wave 2

This Wave will correct the movement of Wave 1. Investors are fearful in Wave 1, but Wave 2 will erase that fear with its activity. Wave 2 can never go anything below the low of the First Wave.

Wave 3

This Wave represents the impulse phase. The asset is now seen as undervalued by investors, which makes its demand go up. This Wave attracts the crowd and will always be longer than Waves 1 and 2.

Wave 4

This Wave is another corrective wave of the impulse phase. This Wave cannot overlap with Wave 1.

Wave 5

This is the final impulse Wave. In this Wave, the massive demand caused by Wave 4 is now reduced to only informed investors.

Corrective Waves

In the corrective waves, the investors see the market as over-priced, and they are labeled a-b-c

Wave A

In this Wave, investors are still very unsure. This makes prices to spiral downwards.

Wave B

This Wave corrects the moves made by Wave A and is supported by low volume but does not take out the high of Wave A.

Wave C

In the Wave, prices tumble. This Wave also extends past the low Wave A and composes sub-waves of 1-2-3-4-5, with the corrective waves having a-b-c sub-waves.

Relationship Between Elliot Waves And Fibonacci

It is no surprise that the Elliot waves are related to the Fibonacci sequence when you consider that the two laws are both laws of nature. The Elliot waves try to put the flow of the market patterns that will easily forecast future prices. In comparison, the Fibonacci tool is the mathematical principle used to know the prize zones. The Fibonacci tool will predict the highest point a trending move will get before it starts to decline. An Elliot wave trader makes the Fibonacci tool the center of his observation when looking to take advantage of all trading opportunities.

Elliot wave analysis is an essential part of correctly forecasting stock prices. The Elliot wave theory is the center of forex wave analysis, and its postulation changed the general perception of the stock market. The stock market that was once regarded unbeatable is now being beaten with regularity, provided the theory is well understood and applied.

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