What is Elliott Wave Theory?
What is Elliott Wave Theory?
Elliott Wave Theory, named after Ralph Nelson Elliott, is a way to predict stock market movements based on patterns. Imagine it like finding patterns in nature. Elliott figured that stock markets move in waves that repeat.
Elliott looked closely at market patterns and could predict market moves by spotting wave patterns. He was inspired by the Dow Theory, which also talks about waves, but Elliott went deeper. He saw that these waves were like fractals in nature. He shared his ideas in a book called "The Wave Principle" in 1938. If you want to master this strategy then take our specialized elliott wave theory course.
The Main Idea of Elliott Wave Theory: Elliott Wave Principle
Think of waves like a dance. When the market goes along with the trend, it moves in 5 waves (called motive waves). When it goes against the trend, it moves in 3 waves (called corrective waves). The first 5 waves are like steps 1, 2, 3, 4, and 5. The next 3 waves are like steps a, b, and c. These patterns show up in short and long-term charts.
Img Ref: Medium
These waves can fit inside bigger waves, like a small piece of broccoli that looks like a big piece. Combining this idea with the Fibonacci numbers helps traders predict and find good trading chances. Get to know about the best share market tips to succeed in intraday trading.
Types of Waves
The Basics Impulse waves are like a team of five smaller waves all moving together in the same direction as the main trend. Think of them as a group of friends going on an adventure. This pattern is really common and easy to spot in the market. It's made up of five waves, where three of them are like the leaders, and the other two are more like helpers.
Img Ref: Investopedia
However, it has some rules to follow:
● The second wave can't go back more than where the first wave started.
● The third wave can't be the shortest among three important waves: the first, third, and fifth waves.
● The fourth wave shouldn't cross over the price range of the first wave.
● The fifth wave should finish with something called "momentum divergence" (think of it like a special ending move).
If any of these rules are broken, then what we thought was an impulse wave might not be. We'd have to change how we see it.
The Fixers Now, imagine the opposite, where there are three smaller waves working to fix things when the trend is going the wrong way. We call these corrective waves. They're like the repair crew for the market.
Img Ref: Pathfinderstraining
Here's what you need to know:
● Corrective waves have five little waves inside them.
● These waves can look like either a getting-bigger shape or a getting-smaller shape, just like a wedge.
● Sometimes, the waves inside the corrective wave might not be five – it depends on the type of shape we see.
● Each little wave inside a corrective wave doesn't go all the way back to where the previous one started. And sometimes, the third wave isn't the shortest.
How to Measure Waves?
Elliott used a special way to measure waves. He called it "degrees." It's like using a ruler to measure different lengths. There are 9 degrees, from really big (Grand Super Cycle) to smaller (Subminuette).
• Grand supercycle: multi-century
• Supercycle: multi-decade (about 40 to 70 years)
• Cycle: one year to several years (or even several decades under an Elliott Extension)
• Primary: a few months to a couple of years
• Intermediate: weeks to months
• Minor: weeks
• Minute: days
• Minuette: hours
• Sub-minuette: minutes
This helps experts figure out where a wave fits in the market.
How Accurate is the Elliott Wave Theory?
While some people criticize the Elliott Wave Theory, they don't show any proof to back up their claims. In our stock market learning app, we have explained all the details about elliott wave theory in depth.
On the other hand, there have been studies that show this type of analysis actually works. For example, in a study called 'Using Fibonacci Retracement and Elliott Waves to Predict Stock Market Prices: Evidence from Amman Stock Exchange Market,' the researcher found that Elliott Wave Analysis can accurately predict how prices will change. Another study, called 'Testing the Effectiveness of the Elliott Waves Theory to Predict Financial Markets: Evidence from the Currency Market,' came to a similar conclusion.
In simple terms, if you do it the right way, Elliott wave analysis can help you predict how prices will change accurately. However, you have to be careful and do a good job of looking at the patterns and labeling them correctly. If you're careless in your analysis, you might make wrong predictions and think that the theory doesn't work.
In our view, the reason some traders say this theory doesn't work is that it seems complicated. But we believe you only need to really understand the patterns and interpret them correctly to make profits using this method.
Wave analysis lets you figure out which way prices might go, giving you a big picture of the market. When you know where prices are headed, you can decide on your goals and when to stop if prices go the wrong way, and even predict trends. This can really help you make smart decisions about investing your money. Earlier, people used this strategy to make money money in intraday trading.
Drawbacks of Elliott Wave Pattern
While Elliott Wave pattern is precise and functional, it does have some limitations that you should be aware of:
● Need for a Strong Grasp: You must thoroughly understand the theory to use it correctly. Sometimes, it's tricky to identify subtle differences between patterns, especially the more intricate corrective ones.
● Not Foolproof: Even though the theory is effective, it doesn't guarantee success. There's always a possibility that a different scenario could emerge and disrupt the expected trends.
● Support Required: Relying solely on wave analysis might not give you a comprehensive view of the market. To make better predictions, it's advisable to combine the theory with other technical tools like moving averages and momentum indicators. You'll also benefit from incorporating fundamental analysis to gain a deeper understanding of a stock's true value.
Trading with Elliott Wave Theory Simplified
Have you ever wondered how traders use something called Elliott Wave Theory to make decisions about buying and selling stocks? It's actually quite interesting, so let's break it down in simple terms.
Imagine you're a trader, and you're watching the movement of a stock. Now, sometimes this stock goes up really fast - that's what we call an "impulse wave." So, if you see the stock going up like this, you might decide to buy it, thinking it's going to keep going up for a bit.
But here's the trick - Elliott Wave Theory suggests that after this upward ride, there might be a change. This change is like a U-turn - the stock might start going down. So, when you see that the stock has gone up a bunch and you think it's going to turn around, you might decide to sell it. This is called "going short."
Now, let's talk about the cool idea behind all of this. Imagine you have a special pattern that appears in the stock market. This pattern is called a "fractal pattern." It's like a shape that keeps repeating itself over and over, but in different sizes. Think of it like a never-ending pattern that gets smaller and smaller.
This Elliott Wave Theory is kind of like that! It's based on the belief that these fractal patterns happen in the world of money and stocks. So, when traders use this theory, they're looking for these patterns to help them make smart choices.
Nowdays traders also using btst strategy in trading and making good profits on it.
To sum it up, Elliott Wave Theory is a way for traders to predict when a stock might go up or down. They look for special patterns that repeat themselves, just like those cool shapes in math that never seem to stop. So, next time you hear about traders using Elliott Wave Theory, you'll know that they're basically looking for patterns to help them make the right moves in the stock market.
Elliott Wave Theory Today
Today's markets are different from the 1930s when Elliott started. We have stocks, forex, commodities, and bonds. Elliott's idea started with stocks, but now we know that some markets move differently. We still see 5-wave moves, but we notice more 3-wave moves. Markets can move in the same direction in 3-wave patterns. This means trends don't always have to be in 5 waves. So, when you're looking at charts, remember that not everything follows the old 5-wave rule.
Que 1. What is the accuracy of Elliott Wave Theory?
Ans: The Elliott Wave Theory helps us understand how prices change in markets, like the stock market. But, it has some important things it doesn't consider. It doesn't pay attention to things happening outside of the market, like politics, economic news, or surprising events. This can make it not so accurate when guessing what prices will do next.
Que 2. What's the Best Time to Use the Elliott Wave?
Ans: There's no one-size-fits-all answer to this. It depends on how you like to trade and what kind of person you are. If you're someone who trades within a single day, you might want to look at shorter timeframes like hours, 30 minutes, or 15 minutes.
Que 3. Can We Always Trust the Elliott Wave?
Ans: Well, here's the thing. The Elliott Wave is like a coin toss. Sometimes it works, sometimes it doesn't. On average, it's right about half the time.
Que 4. Which Elliott Wave Should We Watch Out For?
Ans: Among the Elliott Waves, the third one is like the strongest superhero. It's big and powerful. During this wave, good news comes out, and people who study companies' performance think they'll make more money. So, prices go up fast, and when they dip down a bit, they don't stay low for long. This wave usually lasts the longest.