Introduction to Elliottwave - The Basics Theory Part 1
Posted by: Elliott Wave in Elliottwave, tags: Elliottwave, motive-waveIntroduction to Elliottwave.
Nearly every student of technical analysis has heard of the Elliott Wave Theory and is probably fascinated by the concept. However
despite its popularity, Elliott Wave is also the least correctly understood theory of technical analysis. Too many traders have found the
numerous rules behind Elliott Wave Theory to be overly complicated and subjective. For those who correctly understand the rules,
Elliott Wave Theory has proven to be a reliable basis for interpreting and forecasting price action. For those who misinterpret the rules,
incorrect forecasting will lead many to conclude that Elliott Wave Theory is obsolete. Nevertheless, many traders have used Elliott
Wave Theory to successfully identify turning points in price action.
Elliott Wave Theory: The Basics
Developed by Ralph Nelson Elliott in the 1930s, Elliott Wave Theory was originally designed to forecast stock price movement. Over
time however, the theory has been applied to a variety of markets, particularly foreign exchange. It’s higher popularity in the foreign
exchange market stems from the fact that 80% of the volume in the FX market is speculative. This is important since waves are based
upon mass psychology. Elliott Wave Theory is now a very popular analytical strategy frequently used by the technicians of leading
investment banks and intermarket players.
The Elliott Wave Theory is founded on the notion that markets are not perfectly efficient. As a result, prices from one moment to the
next are not random but rather subject to changes in overall investor behavior—changes that can be predictable with an understanding
of mass psychology.
Elliott went so far as to give names to the different wave degrees. In order of increasing scale or degree, they are: subminuette, minuette, minute, minor, intermediate, primary, cycle, super cycle, and grand super cycle.
He also gave a name to both the five-wave rally and the three-wave decline. A five-wave structure is called an “impulse” wave – a trend move. The three-wave structure is called (not surprisingly) a “corrective” wave – it goes against the trend.
Impulse Waves: The ability to count from one to five does not make one an Elliott analyst. There are two inviolate rules that help the analyst to determine when a “five” really is a legitimate impulse wave.
In an impulse wave, the fourth wave cannot overlap the first wave. In other words, the end of the wave 4 correction cannot penetrate the terminus of wave 1.
Wave 3 can never be shorter than both waves 1 and 5. Wave 3 can be shorter than either wave 1 or wave 5, but not both. Indeed, wave 3 is often the longest and strongest impulse wave within the sequence.
There is a third element that is referred to as “The Rule of Alternation”, although we tend to view it as a strong guideline. In a five-wave sequence, the analyst should expect waves two and four to alternate in their complexity. For example, if wave 2 is fairly straightforward, wave 4 is likely to be more complex or frustrating. The opposite is also true.
Thus, if a rule is broken, the analyst will have to take what superficially looks like a five-wave pattern and safely assume that a different wave count is unfolding.
Impulse waves are labeled with numerals.
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