Elliott Wave Theory for Forex Markets

Introduction:

Ralph Nelson Elliot developed the Elliott Wave in 1930. It is a type of technical analysis. The theory tends to break down fluctuations in the market into repetitive patterns by a progression of waves. This theory was inspired by the waves in the sea. Elliot uses sea waves to describe the financial markets. Waves can also define price movements and consumer behaviour. In 1900, Thoriest tried to connect nature to market behaviour, but only Elliot was successful. The theory was named biomimicry, which was the basis for wave theory. The theory got famous in 1935 when Elliot predicted a market bottom. Some consider Elliot as the worthy successor of Charles Dow. Elliot has given a precise definition for every market phase and confirmed the theory of Charles Dow.

The Principle:

The phenomenon is driven by economic flows, psychological currents and controlled by the laws of nature. If these were missing, then there would be no balance, and drastic fluctuations in the market will occur. The phenomenon is made and used by humans. That's why it is filled with the irrational behaviour of humans. The movement of price results from human activity; therefore, based on nature rules, it shows bearish and bullish trends that reoccur in the market. These recurring trends can be used to form a general model. The wave pattern relates to human psychology in Elliot theory. Their mood creates patterns that alter between optimism and pessimism. Elliott added elements for forecasting that can identify trends and calculate achievable price levels. Elliot waves theory is similar to Charles Dow Theory because both define the price movements in waves. Elliot gives stress on observing nature to grasp the basic trading cycles.

Types of Elliott Wave Theory:

Elliott wave theory is the most popular technical analysis tool in the forex and other financial markets. It is beneficial for you. Suppose you can understand the Elliot theory and its variation because it is one of the most effective ṭechnical analysis tools to date. There are 2 types of waves in the Elliot theory, Impulsive and corrective waves. The impulsive wave is a structure with 5 waves, and the corrective way is a structure with 3 waves. Thus, there are 8 waves in the basic structure. The first 5 waves create impulsive or upward movement, and 3 sub-waves create corrective movement. There are endless cycles where there is one cycle of short duration. There are 34 cycles in the complete cycle, and each wave is divided based on the basic cycle. Waves moving with the trend are called impulse waves, and waves moving against the trend are called corrective waves.

Impulsive Wave

According to Elliott wave theory, the market moves in a 5-3 pattern. The repetitive pattern comprises 8 waves regardless of the market being bullish or bearish. The waves that move in a trend direction are called impulsive waves. These are the first 5 waves. There is a significant price move in the impulse waves, and two impulse waves are shorter than one. It's the third wave, usually as masses increase the price.

Wave 1 is the increase in initial price as people buy the stock at a low price.

Wave 2 is reversed because prices fall as people gain profit.

Waves 3 is an increase in price because masses decide to trade.

Wave 4 is people make a profit out of it as the price of the instrument increase.

Wave 5 is some bullish traders purchasing an overpriced instrument.

Corrective Waves

Corrective waves are three waves that come after the 5 waves. These waves are moving in the opposite direction of the impulse waves. It will rise and fall according to the bearish and bullish trend. Enough though these waves are not identifiable like impulse waves, there are 3 types of chart formation:

Zigzag

When waves are in a zigzag formation, the second wave is the shortest.

Flat:

It is the most straightforward formation as the length of each wave will be the same. There will be a sideway pattern for wave 1 as it will correct the impulse wave.

Triangle:

5 Sub waves create this formation. Each side is divided into 3 sub-waves which makes it a 3-3-3-3-3 structure. The wave is a combination of both flat and zigzag patterns; that's why it is complex. There are converging, and diverging trend lines in this pattern, and these lines are moving sideways. Triangle represents low volatility and volume. When there is a strong price movement, Top and bottom trend lines will peak.

It is more unpredictable than others because it can be increasing, decreasing, expanding, and symmetrical.

Conclusion:

Elliott wave theory relates the investor sentiments to the wave in price charts. There are two types of waves: impulsive and corrective waves; impulsive waves move with the trend, and corrective moves against the trend. The theory is inspired by nature, and it helps in reading the recurring patterns in the price charts. It helps in setting the stop loss as traders can find out where prices will rise and fall. This theory also helps find out profitable entry and exit points in the market, and it helps make trading decisions.