Elliott wave theory
✤ What Is the Elliott wave theory?
The Elliott Wave Principle is a form of technical analysis that traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors. It was developed by Ralph Nelson Elliott in the 1930s.
✤ Core Concepts of Elliott Wave Theory
✤ Wave Patterns
☛ Elliott proposed that financial markets move in repetitive cycles or "waves" that reflect investor sentiment.
✤ There are two main types of waves:
☛ Impulse Waves (Motive Waves) – move in the direction of the overall trend.
☛ Corrective Waves – move against the trend.
✤ Structure of Elliott Waves
✤ Impulse Wave (5-Wave Pattern)
Occurs in the direction of the main trend. It consists of five waves:
- Wave 1: Initial move up.
- Wave 2: Market pulls back.
- Wave 3: Strongest and longest wave; bullish optimism.
- Wave 4: Profit-taking or small correction.
- Wave 5: Final push by the last buyers (sometimes weaker momentum).
☛ After these five waves, a corrective phase begins.
✤ Corrective Wave (3-Wave Pattern)
Corrects the main trend with three waves, labeled A-B-C:
- 1. Wave A: Initial drop (or rise in downtrend).
- 2. Wave B: Counter-trend move.
- 3. Wave C: Continuation of the correction, usually equal or greater than wave A.
✤ Fractal Nature
Elliott Waves are fractal, meaning each wave is made up of smaller waves that follow the same pattern. This allows you to apply the theory on different time frames, from minutes to decades. For example:
☛ A Wave 1 in the daily chart might itself contain a smaller 5-wave pattern in an hourly chart.
✤ Wave Degrees (Scales of Waves)
Elliott identified several degrees of wave cycles, including:
| Wave Degree | Description | Time Frame(approx.) |
|---|---|---|
| Grand Supercycle | Multi-century | Hundreds of years |
| Supercycle | Multi-decade | 40-70 years |
| Cycle | Multi-year | 1-10 years |
| Primary | Monthly/Yearly | Months to years |
| Intermediate | Weekly | Weeks to months |
| Minute | Daily | Days to weeks |
| Minuette | Hourly | Hourse to days |
| Minuette | Intraday | Minutes to hours |
| Subminuette | Very short-term | Seconds to minutes |
✤ Rules & Guidelines
✤ Elliott Wave Rules (must not be broken):
☛ Wave 2 cannot retrace more than 100% of Wavw 1.
☛ Wave 3 cannot be the shortest of the three impulse waves (1, 3, 5).
☛ Wave 4 cannot enter the price territory of Wave 1.
✤ Guidelines (not strict rules):
☛ Wave 3 is usually the longest and most powerful.
☛ Wave 5 often ends with divergence in momentum indicators (e.g., RSI).
☛ In a correction, Wave C is often equal in length to Wave A
✤ Application in Trading
✤ Traders use Elliott Wave analysis to:
☛ Predict future price movements.
☛ Identify market turning points.
☛ Combine it with other tools like Fibonacci retracement, RSI, or MACD for better accuracy.
