The Elliott Wave Theory

Elliott Wave Theory is a form of technical analysis used to identify patterns of behaviour within trading activity. The theory is centred around trader sentiment, and the belief that trader behaviour is predictable and recurring. Within the Elliott Wave Theory, market sentiment is identified by sets of impulse waves and corrective wave, each wave representing a particular moment in market psychology.

Elliott Wave Theory is fractal, this means that a set of wave patterns identified on a smaller time frame, will form a single wave on a larger time frame. Therefore, understanding the Elliott Wave sequence and how to read the waves, means that current market sentiment on a longer time frame can be traded.

Being able to count waves in practice is not as simple as it may sound. There are a set of defined rules that must be followed, but once mastered, can provide a valuable asset in a trader's armoury.

The Elliott Wave Theory

Elliott Wave Theory is a form of technical analysis used to identify patterns of behaviour within trading activity. The theory is centred around trader sentiment, and the belief that trader behaviour is predictable and recurring. Within the Elliott Wave Theory, market sentiment is identified by sets of impulse waves and corrective wave, each wave representing a particular moment in market psychology.

Elliott Wave Theory is fractal, this means that a set of wave patterns identified on a smaller time frame, will form a single wave on a larger time frame. Therefore, understanding the Elliott Wave sequence and how to read the waves, means that current market sentiment on a longer time frame can be traded.

Being able to count waves in practice is not as simple as it may sound. There are a set of defined rules that must be followed, but once mastered, can provide a valuable asset in a trader's armoury.

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Further Reading

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Origins Elliott Wave Theory

The Elliott Wave Theory is a tool used in technical analysis and is designed to identify current market sentiment, furthermore, where that current sentiment sits within a larger frame of trading psychology. The theory was developed by Ralph Nelson Elliott in the 1930s when he was studying several years of data across various indices. Elliott rose to prominence when his theory correctly predicted the stock market bottom in 1935. The theory has since become a reliable and widely used tool for financial institutions and speculative traders across the globe. 

Elliott Wave works on the principle that price movements can be predicted by studying historical price activity. Forex markets move in wave-like patterns driven by investor sentiment and movements are seen in repetitive wave patterns.

"Very extensive research in connection with practically all human activities indicates that social-economic processes follow a law that causes them to repeat themselves in similar and constantly recurring serials of waves or impulses of definite number and pattern. It is likewise indicated that in their intensity, these waves or impulses bear a consistent relation to one another and to the passage of time." - R.N. Elliott 1938

Types Of Elliott Waves

In his theory, Elliott defined two types of waves: the impulsive wave (which has a structure consisting of 5 waves) and the corrective wave (which has a structure consisting of 3 waves). The basic cycle consists of 8 waves: the first 5 waves create an “impulse” movement, and the following 3 sub-waves form a corrective wave.

An impulse wave should be quite easy to identify as trading volume should be increased in the three waves that are in line with the trend, and lower in the smaller corrective waves. The pattern is easier to identify on longer time frames due to less market noise, so if you are having difficulty identifying the pattern on a 30-minute chart, zoom out to 1hr and see if that helps you identify where current price is.

» Counting Impulse Waves

A corrective wave when discussing Elliott Wave Theory is a movement against a larger trend. It can be a common mistake by new traders to assume that "corrective" means bearish or downward momentum. Forgetting that both corrective and impulse waves can move in either direction makes it difficult to count waves.

Corrective waves are not as easy to identify as an impulse wave as they can comprise of different formations, generally three waves, triangles or combinations of the two. Counting corrective waves can be extremely challenging at first and we have written a guide specifically to the feat of counting and understanding the characteristics of a correction wave pattern.

» Complete Guide To Corrective Wave Patterns 

Frequently Asked Questions

What Is Elliot Wave Theory

The Elliott Wave Theory can be used as form of technical analysis when Forex trading. It helps to identify long term trading patterns based on trader sentiment and the psychology of group behaviour. Elliott Wave is focused on market behaviour and identifies wave patterns, each having its own characteristics and divided between impulse and correctional waves.

There are two forms of waves, impulse and corrective. An impulse wave moves in the direction of a longer trend whereas corrective move against the trend. Being able to identify current market sentiment and where it sits within a trading pattern, allows traders to predict the forthcoming wave I.e., impulse or corrective.

Does The Elliott Wave Theory Work

Elliott Wave theory is one of the most widely used techniques when completing technical analysis. Large financial institutions along with speculative traders use the theory when determining future price movement. Due to is popularity, it is safe to say that Elliott Wave theory does provide traders with accurate predictions, only if it is used correctly!

Counting waves is a major component in applying Elliott Wave to Forex trading. There are very specific rules to counting both impulse and corrective waves and if these are not followed, it will lead to an incorrect interpretation of the wave structure.

It is important to remember that Elliott Wave may be considered a reliable indicator, however, like every other technical tool, it is not an exact science.

Is Elliott Wave Good For Forex Trading

The Elliott Wave theory was developed using various indices, but the theory is centred around group behaviour and market sentiment. The underlying principles of the theory are transferrable to Forex trading and every online broker will have Elliott Wave technical indicators in the tools available to the trader.

Which Time Frame Is Best

Elliot Wave theory is fractal, this means that it can be used on any time frame.

The wave theory breaks group behaviour into wave patterns known as impulse and corrective waves. An impulse wave will consist of five waves in the direction of the trend and will be followed by a corrective three wave in the opposite direction. Each impulse wave will be formed of a smaller five pattern and each corrective wave will consist of a smaller three wave pattern.

The fractal nature allows a trader to identify where market sentiment sits within a larger time frame.

Which Elliott Wave Is Strongest

Wave three in an impulse wave is always the biggest and has the most momentum. This means that getting in early on wave three is the big-ticket ride. During this period prices rise rapidly, and volume of trading is extremely high. Wave 3 is where much of the public concede that the previous bear trend is well and truly over and exit their positions to trade in the new emerging trend. Wave 3 generally extends around 1.618 times the size of wave 1.