Education

Ralph Nelson Elliot outlined the concepts of Elliot Wave Theory in the late 1920s. He realized that sock markets, commonly believed to move haphazardly, in fact had a particular patterning behind their movements. This course will shed some light on the history of this highly popular trading technique and thoroughly scrutinize some key features that will make its application more accessible to beginners.

Cycles and Waves

By looking at the historical price volatility of US stock market Mr. Elliot managed to identify that prices reacted heavily on the outside influences. That’s when he found that markets were to a great extent driven by human psychology and generally vulnerable to crowd behavior. He noticed that range of price fluctuations consisted of upward and downward swings, which could be further subdivided into smaller moves that Mr. Elliot effectively called “Waves”. He was able to break them down further and found that each wave could be broken into similar structural components, albeit on shorter time frames.

This further proved the concepts of Dow Theory, which in its essence underscored the importance of fractals in the process of price formation. Fractals are mathematical structures, which on an ever-smaller scale infinitely repeat themselves. Elliott discovered stock-trading patterns were structured in the same way. He then took the next obvious step and began to look at how these repeating patterns could be used as predictive indicators of future market moves.

Market Predictions Based on Wave Patterns

Having discovered this unique characteristic of price behavior, Elliot moved forward to effectively employ the theory and made a series of successful market predictions based on his newfound study. He identified 2 type of waves: impulsive and corrective waves. An impulsive wave which is usually a part of the main trend is comprised of 5 waves, 3 of which are impulsive and 2 corrective respectively. On a smaller scale, each impulsive wave can be resolved into components which essentially include the same 5-wave pattern which can be further subdivided into similar pattern. This process has infinite number of repetitions.

Theory Interpretation

The Elliott Wave Theory is interpreted as follows:

  • Every action is followed by a reaction.
  • Five waves move in the direction of the main trend followed by three corrective waves (a 5-3 move).
  • A 5-3 move completes a cycle.
  • This 5-3 move then becomes two subdivisions of the next higher 5-3 wave.
  • The underlying 5-3 pattern remains constant, though the time span of each may vary.

 

Bottom Line

Elliot Wave theory has gained quite a huge following since the introduction. Many prominent analysts have further expanded this school of thought by developing effective strategies based on this concept. For example, Elliot Wave works great in conjunction with Fibonacci. Such combination is used to identify the extent of retracement in fractal waves.

On the other hand, this concept is not very accessible for beginners: one of the biggest challenges faced by Elliot Wave practitioners is identifying the beginning of new trend for further analysis. The concept is already quite complicated when looking in the retrospect, let alone when trying to apply it on new trend. Regardless of whether you are a devote or a detractor of this study, this section of our technical analysis course serves the purpose familiarizing you with this interesting concept and will help you understand how to apply it effectively and make constant profits.