Elliott Wave is a trading strategy created by accountant Ralph Nelson Elliott in the 1930s. It is a technical market timing strategy which can be used to predict price movements based on historical price wave patterns along with their underlying psychological motives. Traders use the Elliot Wave principle to identify highs and lows in prices and a number of other collective factors. The strategy utilizes information on the specific patterns in which market prices unfold. These patterns are called waves and are an excellent tool to trade forex markets.
The Elliott Wave theory of market behavior was published in 1938 in a book called The Wave Principle. The theory was also summarized in several articles published in 1939 in Financial World magazine. The most comprehensive description of the Elliott Wave was Elliott’s book ‘Nature’s Laws: The Secret of the Universe’. In it Elliott shows how man being subject to ‘rhythmical procedure’ makes it possible to predict his future actions using the appropriate calculation. The Elliott Wave Theory calls for the use of information on market trends combined with the predictability of the actions of humans to anticipate activity in Forex and other markets.
The technical analysis involved in Elliot Wave theory is easily adaptable for use in forex markets. Market trends are driven in part by investor psychology. This is true in forex and all other markets. Elliot Wave principle provides the tools to understand investor psychology and leverage that information to make timely trades in forex markets. Successful investors understand market trends are cyclical. Therefore when they see prices and markets acting in a particular manner, it’s relatively simple to use Elliot Wave Theory to anticipate what will happen next.
According to Elliot Wave Principle, collective investor psychology moves in natural sequences between optimism and pessimism. These mood swings lead to predictable price movement patterns. Elliott Wave Principle posits market prices, forex or others, always alternate between an impulsive phase and a corrective phase over time. The impulsive or motive wave moves with the trend and the corrective wave goes against it. There are 5 waves in an impulsive or motive phase and 3 waves in a corrective trend. The motive pattern is completed after 89 waves while the corrective pattern is completed after 55 waves.
There is a name for the degree of each pattern in financial markets. Symbols are used to indicate the degree and function of each motive wave. Letters are used for corrective waves. Waves may vary in size or duration. There are classifications used for the approximate duration. They include:
- Grand supercycle: More than one century
- Supercycle: 40 to 70 years
- Cycle: From one to several years
- Primary: Several months to a few years
- Intermediate: Weeks to months long
- Minor: Weeks
- Minute: A few days
- Minuette: A few hours
- Subminuette: A few minutes
Elliott Wave Personality
According to Elliott Wave analysts, each wave has a signature or characteristics that reflects the current psychology. The key to being a successful investor in the forex market is understanding and identifying the characteristics. The Elliot Wave market model requires relying heavily on price charts. Successful practitioners study the trends that are developing in order to distinguish the wave structures and the waves. This helps them to anticipate what prices are likely to do next. Therefore in order to apply the Wave Principle pattern recognition is essential.
The structures that Elliott described meets the definition of what is called fractal. These are self-similar patterns that appear at each degree of a trend. People that use Elliott wave say that naturally-occurring fractals tend to expand and become more complex over time just as collective human psychology and their buying and selling decisions tends to develop in natural patterns and are reflected in market prices. Elliott saw it as the entire universe including humans being programmed by mathematics to act in certain ways.
Current Acceptance And Use
Since Elliott died in 1948, a number financial professionals and market technicians have continued using the Wave Principle to provide guidance for their investors with success. The Wave Theory is used on Wall Street and a number of other markets. Many have used it to guide their investments in the forex market. Several books on Elliott Wave Theory has been written and disseminated to investors to teach about market behavior. It has been discussed on the Financial News Network. Robert Prechter, a Merrill Lynch market technician, had success in the 1980s using it.
Wave analysis is widely accepted among market technicians and is included in the Chartered Market Technician exam. Over several decades it has been accepted by many academics and market technicians and analysts internationally and company’s like AlfaTrade as a good investment probability framework. It’s also a useful tool for trading forex markets.