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| Elliott Wave Theory |
Hello dear readers🙋♂️, in today's article we will try to give information about
Elliott Wave Theory. First, let's look at what Elliott wave theory is. The
question you probably have in mind is:
❓ What is
Elliott Wave Theory?
🌊The Elliott Wave Theory is an important analytical method developed by Ralph Nelson Elliott in financial markets. This theory emphasizes that price movements can be explained by specific patterns of recurring wave patterns. 💼As a financial professional and investor, Elliott argues that market price movements are actually predictable and orderly. Therefore, the Elliott Wave Theory serves as a tool used by investors and analysts to understand price trends and predict potential future price movements.
Ralph Nelson Elliott developed this theory, drawing inspiration from the Dow Theory, and believed that wave movements in financial markets were linked to human psychology. The main purpose of this theory is to provide traders/investors with a framework to make predictions about future price movements.According to the Elliott Wave Theory, price movements in financial markets follow regular and 🔁recurring wave patterns. Elliott Wave Theory argues that price movements in the markets move in a cycle of five waves and three waves: a bullish wave (impulse) and a bearish wave (correction). Bullish waves are the phases when the underlying trend is moving in an upward direction and consist of five sub-waves. Bearish waves are phases where the trend retreats in the opposite direction and consist of three sub-waves. For Example: 👀see images ⬆above and ⬇below
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| Elliott Waves in NZD/USD |
❓ What is the structure of Elliott Wave Theory?
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| The structure of Elliott Waves |
🌊The Elliott Wave Theory is an approach defined by the
5+3 (5-A, B, C) pattern, which undergoes subdivisions. This theory aims to
explain price movements in financial markets within a specific structure. It
progresses with a main wave structure consisting of five waves in the direction
of the trend (5-3-5-3-5) and a corrective wave structure consisting of three
waves in the opposite direction (5-3-5). The main direction is represented by
waves 1, 3, and 5, while the corrective direction is represented by waves 2 and
4. After completing the five-wave pattern, a three-wave correction (A, B, C)
process begins, and this completes the wave pattern. This formed pattern is
considered as the first wave of the next larger pattern, and the ♻cycle
continues accordingly. In the main direction, there are 5 waves with 21
movements, and in the corrective direction, there are 3 waves with 13
movements.
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| Elliott Waves in Alibaba Stock Chart |
❓ How are Elliott waves formed?
According to the Theory, 1️⃣the first wave of price movements is ⬆an upward movement. Typically, one of the waves within the impulse wave, usually waves 1, 3, or 5, tends to extend. It is important for these waves to be noticeably longer than others in terms of both time and price. If one of the impulse waves extends, the others will be of equal length. For instance, if wave 3 extends, waves 1 and 5 will be of equal length. If waves 1 and 3 are of equal length, wave 5 is expected to extend. Typically, the price distance of wave 3 will be around 161% or 261.8% of wave 1. At the very least, it is expected to be of equal length to wave 1. In such a scenario, waves 1 and 5 are predicted to be of equal length. If waves 1 and 3 are close in length, then wave 5 is expected to extend. The extended wave 5 should reach up to 161% of the distance from where the impulse started to where wave 3 ends. In the Elliott Wave Theory, the reference point will always be 1️⃣the first movement, which is wave 1. If the potential target price of a wave is to be calculated, the difference between the starting and ending points of wave 1 is determined, and all calculations are based on this difference.
The 2nd wave retraces by 0.618: This means that the
2nd wave moves backward, correcting itself up to 61.8% of the distance covered
by the previous 1st wave. In other words, the 2nd wave pulls back, reaching
approximately 61.8% of the distance from the starting point of the 1st wave.
The 3rd wave advances by 1.618: Here, it indicates
that the 3rd wave moves in the direction of the trend and extends itself,
covering a distance that is 161.8% of the 1st wave's movement from its starting
point.
The 4th wave retraces by 0.38: This means that the 4th
wave moves in the opposite direction of the trend, retracing approximately 38%
of the distance covered by the 3rd wave from its starting point.
The 5th wave is equal to the 1st wave: Lastly, the 5th
wave is calculated to be equal in length to the 1st wave. In other words, it
should cover a similar distance as the 1st wave's movement. 👀Let's look at the following Example Image:
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| The formation of Elliott Waves. |
❓ What general rules apply to the formation of
Elliott waves?
According to the Elliott Wave Theory, waves 2 and 4
within the price movements progress in opposite directions. If the 2nd wave has
a zigzag structure, the 4th wave can be a flat and straightforward correction.
Conversely, if the 2nd wave has a horizontal structure, the 4th wave may
exhibit a zigzag correction.
The 2nd wave tends to retrace by around 0.62%, while
the 4th wave usually retraces by approximately 0.38%. Additionally, if the 2nd
wave retraces by 0.50%, the 4th wave may retrace by 0.23%, and vice versa. If
the 2nd wave takes a longer time to form, the 4th wave can be completed in a
shorter period, and vice versa. Furthermore, if the 2nd wave has a simple
structure, the 4th wave tends to have a more complex structure. 2nd waves often
make sharp corrections and show zigzag, double zigzag, or triple zigzag
structures. In rare cases, the 2nd wave can have a triangular structure. On the
other hand, the 4th wave generally makes a horizontal correction and can have a
flat, double flat, or triangular structure.
Both the 2nd and 4th waves need to retrace by at least
0.236% of waves 1 and 3 to be confirmed as valid waves. Common retracement
levels are considered to be 0.382%, 0.50%, and 0.618%. Following a short
correction wave, a strong movement can occur. Often, the 2nd wave extends to
the level of the 4th wave of the previous smaller-degree wave. The 2nd wave
fully retraces the 5th wave of the previous smaller-degree wave and covers the
4th wave level.
For the 5th wave, it needs to advance by at least
0.618% of the 4th wave. The 5th wave of a sub-degree of the 3rd wave cannot be
an unsuccessful 5th wave. Expected termination levels for the 5th wave are
considered to be 0.618%, 1.00%, and 1.618%.
In an uptrending impulse wave, it typically rises by
surpassing the peak level of a preceding wave of the same degree, whereas in a
downtrending corrective wave, it falls below the trough level. If the
identified wave on the chart does not exceed the peak or trough level of the
previous wave, it should be considered as belonging to a smaller degree.
Impulse waves observed in price movements often exhibit sharp changes in
direction, rapidly propelling the price upwards or downwards. These waves
generally progress with a stronger momentum compared to corrective waves and
are indicative of the continuation of the trend. On the other hand,
downtrending corrective waves have a restraining and corrective structure that
slows down the price movement. These waves emerge when the price reacts against
the movement of the previous impulse wave, attempting to balance the price with
a corrective movement.
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| Elliott Waves in EUR/JPY Pair |
❓ How reliable is Elliott Wave Theory?
🌊Elliott Wave Theory suggests that price movements in
financial markets follow an order and pattern. Therefore, markets are thought
to have certain cycles and repeating patterns. However, the application of the
theory is not always conclusive. While the Elliott Wave Theory is ✅considered by
some traders and analysts as a successful tool for predicting price movements
and identifying trends, ❌others criticize the theory and believe that it is not
reliable. According to them, the theory's process of identifying and predicting
certain waves can be subjective and open to different interpretations. Also,
since there are many complex factors that influence price movements in the
markets, the Elliott Wave Theory alone cannot be expected to always provide
accurate results. Therefore, when using the Elliott Wave Theory, one should
integrate other methods of analysis and always consider ❗the risks involved.🔚