Elliott Wave Theory is a form of technical analysis to analyze financial market cycles and forecast trends. It is named after Ralph Nelson Elliott (1871 – 1948). Inspired by the Dow Theory and by observations found throughout nature. Elliott concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves.
Elliott noted from his observation that movement in the direction of the trend is always in five waves, labelled as 1, 2, 3, 4, and 5. This is usually called motive wave. Movement against the trend is always in three waves and this is called corrective wave. Three wave corrections are lettered as “a, b, c.“
Elliott observed the fractal nature of waves: smaller patterns can be identified within bigger patterns. In this sense, Elliott Waves are like a piece of broccoli, where the smaller piece, if broken off from the bigger piece, does, in fact, look like the big piece. This information (about smaller patterns fitting into bigger patterns), coupled with the Fibonacci relationships between the waves, offers the trader a level of anticipation and/or prediction when searching for and identifying trading opportunities with solid reward/risk ratios
Today’s trading environment however is different than the one in 1930s when Elliott Wave Theory was invented. Today, we have computer algos and machines trading in seconds or milliseconds purely based on technical, probabilities, and statistics. In today’s environment, the biggest change is in the definition of trend and counter-trend move. In today’s market, trends can move both in 3 waves and 5 waves. In other words, trend can move in corrective structures and thus we believe that trends do not have to be in 5 waves.
This text is taken from opening slides of the Elliott Wave Structure and Fibonacci Ratio Seminar we conducted on February 1st, 2017 and you can watch the recording below:
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