Elliott Wave Theory
The ebb and flows of the market, have been analyzed for decades, and one technical analysis theory that can be used to evaluate the bigger picture of where the market is going is Elliott Wave Theory. This concept was developed by R.N. Elliot. Waves reflect sentiment along with fear and greed. Elliot described price changes in the financial markets. He described five basic wave sequences and three corrective sequences. There are rules and guidelines, that help determine the stages of each market movement. If you are trading the currency markets you can use the Elliot wave principle to determine what the forex trend is.
The conventions used in the labeling of waves describes the size of the uptrend along with the length and depth of the wave. When you evaluate an Elliot wave sequence from 30K feet you see 5-impulse waves that are counted from 1 to 5, and three waves corrective waves that are labeled A,B and C. When the impulse wave moves higher, (waves 1,3 and 5) the corrective waves move lower. When the impulse waves decline (waves 2 and 4) the corrective waves move higher.
There are two types of waves which are the impulse waves, and correction waves. Impulse waves move in the general direction of the underlying trend, while correction waves move in the opposite direction. The impulse wave in an uptrend is made up of 3-waves which define the trend. The complete Elliot wave sequence is 3-waves up and 2-waves down. Or 3-waves down and 2-waves up. Within ease impulse movement there are correction waves that retrace the trend as sentiment changes within the market.
There are several hard and fast rules that provide the backdrop for the Elliot wave theory. In addition, there are several guidelines, that help provide the subjectivity to the analysis. While there are some technicians that follow the Elliot wave principal to a tee, many analyst use the wave structure as a guide for future price action.
Rule number 1, is that the second wave cannot completely retrace the first wave. So, you need to have a higher high and a higher low, which also describes and uptrend. The second rule is that wave 3, cannot be the shortest wave. It does not have to be the longest wave which is what occurs most of the time. Wave 4, cannot overlap wave one, which is the 3rd rule.
The corrective nature of waves 2 and 4 will alternate. This means that you will not likely see the same contraction in price action from both waves. While wave number 3, does not have to be the longest wave, it is generally the largest and is the heart of the trend. While wave one is usually perceived as the break out, wave three is where most traders get on for the ride in a trending market. Wave 5- is usually considered the shortest wave, as late comers to the trend get aboard for a short ride.
The Elliot Wave Principle attempts to provide rules that reflect the ebb and flow of the market. Elliot describe the cycle nature of the market in 5-impulse waves and 3-corrective waves. By following the waves, you outline the broader market changes, and where they could potential pivot. If you apply the rules for the first count and guidelines for the second you are likely to evaluate the waves in the proper manner. By eliminating false wave you will be able to target specific areas of a trend and improve levels to initiate a trade or take profit.