In 1920, Ralph Nelson Elliot developed Elliot Wave Theory for the stock market. Elliot realizes that stock market traded in recurring cycles in response to investors and exterior factors. He finds that upward and downward fluctuations have recurring patterns and from theses recurring patterns divided again into patterns that he name as waves.
An impulsive wave that comes with the main trend will always have five waves and another five smaller waves in the each wave. The same pattern recurs in theses smaller waves.
In all markets, trends and retracemet are form by prices which Elliot name as impulsive and corrective waves.
Understanding Elliot Wave Theory
- Every movement is accompany by a reaction
- A main trend consists of five waves accompany by three corrective waves which is a complete cycle.
- The complete cycle is then turn into two subsection of another five waves and three corrective waves.
- The time span for each wave varies.
- The five waves labeled as one, two, three, four and five.
- The three corrective waves are labeled A, B and C.
Corrective wave usually has three price movements,
- Two price movements that move in the same direction as the main corrective wave. (A and C)
- The other price movement will move against the direction of the main corrective wave. (B)
The corrective wave has the following formation:
- Wave A and wave C moves in the same direction of the short-term trend and are impulsive waves with five waves.
- Impulse waves always follow by corrective waves.
- Elliot wave comprises of trends and countertrends.
Applying Elliot Wave Theory to Forex Trading
Each trend and countertrend in the forex market moves in five waves,
- Three upward waves, wave no. 1, 3 and 5.
- Two downward waves, wave no. 2 and 4.
- Each five upward waves move will be accompany by five downward waves.
- The downward waves consist of downward wave no. 1, 3 and 5 with upward wave no. 2 and 4.
- Each countertrend wave no. 2 and 4 will form another corrective wave, wave A, B and C.
- In wave 1, market retraces forming two smaller waves, wave A (down), B (up) and C (down).
- Similarly with waves 2 and 4 of the five downward wave comprising of two small upward waves A and C and one small downward wave C