Elliott Wave Theory Review in Market Work
Welcome to our website which is devoted to economics, finance and, of course, currency trading and various assets in international markets. In this article, we take a look at such a popular method of technical analysis as Elliott Wave. You will be able to use this knowledge to forecast currency rates and increase your profits.
For a better understanding of Elliott Wave Theory, we will conduct a brief excursion into history (where without it). The father and ideological inspirer of this theory was a widely-known American financier and accountant Nelson Elliott (July 28, 1871 – January 15, 1948). In his work “The Wave Principle” published in 1938 Elliott put forward his postulates. The wave theory is the development of the Dow theory, we will definitely tell about it in the following material, and is applied to the traded assets. Elliott, starting to study market charts, wanted to reveal a way to determine patterns of the market. Having accumulated a lot of material, he concluded that the market itself is the result of mass psychology and lends itself to certain rules.
The foundation of the theory is cyclical regularity in the psychology of human behavior. In accordance with this theory, prices may be clearly identified and showed. The wave is a clearly distinguishable price movement.
Elliott suggested that movement and price changes are divided into:
– five waves in the direction of the main trend (waves 1-5)
– three waves in the reverse direction (A, B, C)
The waves themselves are also separated:
– Pulsed: cause a trend (ascending/descending), make the market move significantly (1,3,5, A, C).
In this theory, all waves are elements of longer wavelength intervals, and the waves are divided into even smaller sections. Each wave is divided into 3 or 5 wave sections, this division is calculated from the direction of the larger wave section, of which the smaller wave is a part.
The main rule of this theory is that any impulsive wave covers five smaller ones. The corrective wave contains three small ones.
In this theory, there is also the “Big Supercycle”. It includes 8 waves of the supercycle, they are divided into another 8 waves. The second picture is the image of the three main cycles. It should be noted, in this figure, the proportionality of impulsive and subsequent corrective waves. The stronger the impulse, the stronger the corrective wave and vice versa. One of the difficult moments in the theory is to correctly detect waves. Most often, corrective waves are very difficult to identify.
As we wrote earlier, the Fibonacci numbers fully confirm the “Elliott Theory.” But what really far to go, the author of this theory himself personally admitted, he borrowed the mathematical basis of his theory from the legendary 13th-century Italian scientist Leonardo Fibonacci. Thus, the Fibonacci numbers play a significant role in constructing the cycles described by Elliott. Since the number of waves that build a trend corresponds to Fibonacci numbers.
The picture above shows that the complete cycle combines two large waves, eight medium-sized waves, and 34 small-sized waves. In a bearish market, a large super cycle contains a big wave, also contains 5 medium, and 21 small waves, etc. following the pattern of Fibonacci numbers.
Thus, a large super cycle of the bullish market contains one big wave, three medium sizes, and 13 small ones. Looking at it more closely, you can count 55 waves of even smaller sizes, etc.
This rule is based on the fact that movement in any directorate continues until a certain number is reached in accordance with the Fibonacci number series.
The price movement, stretching for more than three days, should not reach the fifth day. The movement, which lasts more than 5 days, should last 8 days. The ten-day trend should not end until the 13th day, etc. This pattern of calculating the trend change can be applied to hourly, daily, weekly and monthly data. But it is worth bearing in mind that this is the so-called “ideal model”, so you should not rely on prices to behave so predictably. Discrepancies can occur in time and scope.
Waves, or rather, each wave, have characteristics that are based on market behavior. Let’s look at these characteristics in more detail.
It is worth paying attention to the special features of each of the waves. Also, there are some rules of relationships and the design of the waves (see table). These rules make it possible to clearly distinguish the starting point of waves and their duration.
2 0.382, 0.5 or 0.618 Wavelength 1
3 1.618 or 2.618 Wavelength 1
4 0.382 or 0.5 wavelength 1
5 0.382, 0.5 or 0.618 Wavelength 1
A 0.382, 0.5 or 0.618 Wavelength 1
B 0.382 or 0.5 Wavelength A
C 1.618, 0.618 or 0.5 Wavelength A
Standard wave ratios are acceptable with a 10% deviation. This error occurs due to the effects of various technical or fundamental factors of influence in a short interval of time. The ratio of sizes can be equal to the values of 0.382, 0.50, 0.618, 1.618.
The first wave happens on the condition that the market as a whole is bearish. Continue to receive negative news. This wave is strong, provided that there is a sharp change in this situation (change of trend, a breakthrough of resistance, etc.). With peace of mind, the wave shows small price changes during general indecision.
The second happens in the condition that the market rebounds sharply from the last income positions and can bounce off almost the full cost of the first wave, but no less than its starting point. Often, it is equal to about 60% of the first wave and develops in conditions of domination of traders who fix income.
The third is the most important for the adherents of Elliott’s theory, and they are looking forward to it. During this wave, there is a sharp rise in optimism among investors. This wave is the strongest and longest rising wave. The standard third wave is not less than 1.618 times the first one.
The fourth – it is difficult to identify. Often it falls on a rate of no more than 38% of the third wave. The depth and length are small, and the optimistic trend will prevail. This wave should not close the second wave until the cycle of five waves becomes an element of the terminal triangle.
The fifth wave is most often indicated by impulse divergence. Price increase on average trading volumes. By the end of the wave, as a rule, there is a sharp increase in trading.
A-wave – Most traders believe that growth should continue in the near future with new energy, but there are traders who consider the opposite. The values of this wave are similar to the first.
B-wave is often similar to the fourth, it is difficult to identify. It shows a slight upward movement on the remnants of optimism.
C-wave is a powerful decrease during the general confidence about the start of a new decrease trend. Individual traders start buying assets with caution. This wave is characterized by high impulsivity (5 waves) and it stretches up to 1.618 times the third.
In order to correctly determine the trend using this toolkit, Ralph Elliott developed the main rules, and later with the development of the market, other rules were added to the basic rules.
The main should include:
– The fact that the trend is developing should be questioned if the second impulsive wave has dropped to the starting point of the first wave.
– The third impulsive wave must be above the top of the first wave. The third impulsive wave should not be shorter than the other two impulsive waves if we talk about large-scale periods of time.
– The fourth impulsive wave should not be lower than the maximum point of the first impulsive wave. Sometimes they close their eyes to this point, provided that the fifth impulsive war is above the maximum value of the third impulsive wave.
There are also additional rules:
– The development of the trend should be suspected if the correction in the impulse itself does not differ in complexity, size and time of formation (at least in one of these parameters).
– In an impulsive structure that meets the required condition, one of the waves must be larger than the other two.
– Three waves that stand side by side and enter the structure of the impulse must be formed in terms of different duration.
Thanks to these rules, it is possible to see what the structure is – impulsive or corrective. If the wave combines these requirements – it is pulsed if the wave does not have all the requirements in itself, then this structure is either corrective, or the impulse has not yet formed.