What's The Elliot Wave Principle?

FinanceStocks, Bond & Forex

  • Author Cory Norstrom
  • Published February 6, 2012
  • Word count 588

The Forex market on first glance looks extremely chaotic. It's extremely volatile, with many price fluctuations in either direction, over and over again. Getting into Forex without knowing what you're doing is a fool's errand. That's not to say though that it is total random chaos - people have found patterns in the market. One such method for this is known as the Elliot Wave principle.


Elliot Waves are something we'll talk in more detail shortly about what they are specifically, but basically they're price fluctuation patters of a specific kind. The general idea is that markets move in predictable patterns, based on the idea of the mood of investors. Trends move in specific ways and change direction in specific ways as investors jump on or off of them in known patterns. Those patterns are shown in Elliot Waves.


Look no further than Ralph Elliot, an accountant in the 1930s who wrote a book called The Wave Principle. He was able to use his theory originally to make predictions for the behaviour of stock markets, but it turned out that the Elliot Wave principle actually applied to anything involving the psychology of large groups of people. Elliot Waves can be used to predict everything from fashion trends to election results. It's especially useful in the Forex market, as there is a very huge amount of data to analyze, and it involves a massive amount of people making trades every second of every day.


There's a couple of forms of waves in the Elliot Wave principle - impulsive waves and corrective waves. Impulsive waves drive the market. Corrective waves, as you would imagine, supply corrections to those impulses. In order to fall within the Elliot Wave principle, there is a specific pattern to the way these impulsive and corrective waves behave. Whether you're looking at minutes or decades, you'll see Elliot Waves.


There are five dominant trend waves and three corrective trend waves. In a bullish market they trend up then down, in a bearish market down then up. The first wave (Wave 1) is impulsive. The second wave (Wave 2) is corrective, but never to the point that it passes where Wave 1 started from. The third wave (Wave 3) is again impulsive, as more people jump onto a trend, and is often the largest of the waves. It's way past Wave 1. The fourth wave (Wave 4) is again a corrective wave, but not does not overlap with Wave 1. The fifth wave (Wave 5) is the final part of the dominant trend. This is where the dominant trend stops and the corrective trend starts. The sixth wave (Wave A) is the first part of the corrective trend - a correction that starts the overall trend moving in the opposite direction. The seventh wave (Wave B) is the last impulsive wave, actually a correction of a correction, it's a temporary reversal. The eighth and final wave (Wave C), which is the final correction of the overall trend. It's usually even bigger than Wave A. Inside each wave are many smaller waves that look similar to the overall trend. This is known as a fractal - where patterns are similar over all degrees.


You can use Elliot Waves to help determine when to get into or out of a trend. This isn't ESP - they don't predict the future 100 per cent of the time. But they're great for figuring out general market trends.

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