The Elliot Wave Theory is one of the best-known but least-understood ways to use technical analysis in forex trading. Ralph Nelson Elliot came up with the Elliot Wave theory in the 1920s as a way to predict trends in the stock market. It uses fractal mathematics to look at how the market moves and makes predictions based on how people act as a group. The Elliot Wave theory says, in essence, that the market, in this case the forex market, moves in a series of 5 swings up and 3 swings down, which keep happening over and over again. But if it were that easy, everyone would make a lot of money by catching the wave and riding it until it hits the shore. There's a lot more to it, that's clear.
Timing is one of the things that makes riding the Elliot Wave so hard. It is the only major wave theory that doesn't say how long it will take for the market to react and bounce back. A single In fact, it is clear from the theories of fractal mathematics that there are waves inside waves inside waves. It's hard to figure out how to interpret the data and find the right curves and peaks. This is why some people say that you could put 20 experts on the Elliot Wave theory in the same room, and they would never agree on where a stock or, in this case, a currency is going.
How Elliot Waves Work
- For every action, there is a response.
The Elliot Wave theory is based on this general rule of physics about how groups of people act. People will buy if prices go down. When people buy, demand goes up and supply goes down, which makes prices go back up. Almost every system that uses trend analysis to predict how the currency market will move is based on figuring out when actions will lead to reactions that make it profitable to trade.
- Five waves move in the direction of the main trend, and then three waves move in the opposite direction (a "5-3" move). The Elliot Wave theory says that market activity can be predicted as a series of five waves that move in one direction (the trend), followed by three "corrective" waves that move the market back to where it started.
A cycle is complete when a 5-3 move is made.
And now the theory starts to get really hard to understand. Like a mirror that reflects a mirror that reflects a mirror that reflects a mirror, each 5-3 wave is not only complete in itself, but it is also a superset of a smaller set of waves and a subset of a larger set of 5-3 waves. This is the next principle.
- The basic 5-3 pattern stays the same, but the length of each part can change. A 5-3 wave could last for decades or end in just a few minutes. Traders who use the Elliot Wavy theory to trade in the currency market and do well say that the key is to time your trades to start and end with impulse 3 to minimise your risk and make the most money possible.
- The next higher 5-3 wave is made up of two parts of this 5-3 move. The five waves that fit the trend are called 1, 2, 3, 4, and 5 in Elliot Wave notation (impulses). The three waves that try to fix things are called a, b, and c. (corrections). Each of these waves is made up of 5-3 waves, and each of those waves is also made up of 5-3 waves. The 5-3 cycle you are looking at is an impulse and a correction in the next 5-3 series that goes up.
Because the timing of each set of waves is so different, the Elliot Wave theory is very open to different ways of looking at it. To know when to get into a trade and when to get out, you have to be able to see and follow the pattern of bigger and smaller waves and know when to trade and when to get out based on the patterns you see.
The key is to correctly read the pattern and find the right place to start. Experts say that once you learn to see wave patterns and correctly identify them, you'll see how they apply to every part of forex trading and be able to use those patterns to guide your decisions, whether you're in it for the short term or the long term.
