Elliott Wave Theory: the basic principles of the popular indicator markup
Elliot's theory is one of the most serious works in the field of research of quotation charts. In the 1930s, R. Elliot noticed that the price dynamics of an asset has a cyclic nature, and proved the fractality of the stock market. Currently, Elliott waves are a popular technical analysis indicator used by most investors and traders.
This theory is based on the assertion that the behaviour of market participants is basically represented by the same decision-making patterns that depend on current prices. Accordingly, each trend has recurring areas on the chart.
It is possible to distinguish the cyclic, wavy nature of changes in the quotations of any asset. Elliott noticed that the pattern is repeated not only on one-time frame, but also on smaller time frames. This means that one large wave on the chart can be divided into several smaller waves, which also consist of base sections
The scientist distinguished two types of waves:
Impulse - directed towards the trend, are its driving force. They consist of five segments.
Correctional - moving in the opposite direction, there is a rollback of the price. They are shorter than impulse waves and include three segments.
The main wave consists of an impulse and a corrective part, which are divided into the same parts as the main wave.
The waves of the driving segment are designated by the number from 1 to 5, and the corrective part is written down by the letter A, B, and C. A total of 8 waves is obtained.
A supercycle looks like this: impulse waves 1, 3, and 5 alternate with corrective waves 2, and 4, followed by the corrective part A, then growth wave B, and the final part of the decline C.
Each wave is the same set of segments as the super cycle itself, only its parts are marked with lowercase letters, not capital letters. This reveals the fractality of the market.
When the last fifth wave is formed, the trend can:
Unfold: two impulse sections formed by ten segments can be seen on the chart;
Correct: In the most likely scenario, the trader-investor will notice three corrective segments (ABC waves).
Rules for applying the indicator and identifying its components.
Different investors, when analyzing one chart, can come to different conclusions about the market condition.
In order to avoid the subjectivity of perception it is necessary to follow the rules of building waves and their application, derived by R. Elliot and improved by his followers.
If we take the length of the first wave as a base value (x), then the approximate sizes of the other parts:
Second: 0.38 - 0.62 of x, the waves from the corrective section of the 2nd segment have the same size: a=b=c
Third: 1.62 - 2.62 from x
Fourth: 0.62-1.32 from x, a=c and b= 0.24 from a
Fifth: 0.38-0.62 from the third
The wavelength of the corrective segment:
A: 0.5 of fifth.
B: 0.38 - 0.5 from A
C: 0.5 - 0.62 from A (sometimes 1.62 from A)
Other rules include:
The end of the second wave must not be below the beginning of the first pulse.
The third exceeds the top point of the first.
The fourth must not fall below the end of the first.
The fifth must exceed the third, its formation takes more time.
If at least one condition is not met, the wave analysis does not apply to this part of the chart.
Elliott Waves are able to indicate the optimal point to enter and exit the market. They will help traders and investors not to make common mistakes: opening a deal at the end of an impulse or against the trend.
If you want to delve into the wave theory and at the level of a professional wave investor to mark up charts with waves Elliott I recommend reading and studying the following literature:
- Ralph Elliott - The Law of Nature. The Secret of the Universe.
- А. Frost, R. Prekter - The Complete Course on the Elliott Wave Law
- Robert Balan - Elliott Wave Principle Application to the Forex Markets
- Bolton - The Complete Works on Elliott Waves
- Dmitry Vozny - Elliott Wave Code forex market analysis
- Safonov - Practical Use of Elliott Waves in Trading Diagnostics, Forecasting and Decision Making
- Neely - Mastery of Elliott Wave Analysis
- Boriskin V. Harmonic Wave Analysis