Wednesday, April 25, 2012

Elliott Waves Basics

Every complete Elliott Wave move consists of 5 impulsive waves in the direction of the main trend followed by 3 corrective waves (a so called "5-3 move").

This rhythm of 5-3 move remain true for any time frame.

This is an Uptrend, where:

1-2-3-4-5 - is an impulsive move, where waves 1-3-5 are Impulsive waves, 2-4 are corrective waves.

A-B-C - is a corrective move, where A-C are impulsive waves, B is corrective wave.

But, what does this all impulsive/corrective thing mean..?

To understand we have to go back to the mass psychology phenomenon, and here is how it works according to Elliott: 

Wave 1 - represents an impulsive optimism among the first group of Buyers - they have found a good reason to Buy (for technical or fundamental reasons), and so they begin pushing the market higher.

Wave 2 - the impulse fades out as the original Buyers begin to close trades with profits, while other investors who missed the train, stay outside waiting for a new opportunity.

Wave 3 - usually the longest and the strongest wave. Every investor who wanted to Buy (those who missed Wave 1 and those who didn't) will start Buying now. In addition to that, in the middle of the wave 3 those who weren't convinced about an Uptrend will be convinced by now. Altogether this will bring a large acceleration to the main trend. 

Wave 4 - sooner or later it's time to take profits, an impulsive move starts to fade again. However, the correction will be shallow as there are still many Buyers who want to join the trend.

Wave 5 - and so the uptrend restores, but the markets are already overbought and it becomes obvious that a reversal is due. The end of wave 5 is often marked by oversold (in an uptrend) markets and divergence.

Waves A, B, C - these waves develop in the counter-trend style to the major trend. At this point a new trend may develop, but may also not, and the new sequence of 1-2-3-4-5-A-B-C waves may begin.

Degrees of Elliott Waves and cycles

It would be great of we could take those 5-3 waves and go trading, but on practice when we look at price charts there are no such smooth 5-3 waves, instead, it'll look like a maze of up and down swings.  Where to go from here?

Elliott Wave theory says that every wave has smaller waves within it.

 And so, if we now view every wave as a series of smaller waves, the picture will look like this:

Elliott wave cycles

According to Elliott every complete set of 1-2-3-4-5-A-B-C waves becomes a wave of a larger degree ( a wave of a larger cycle).

Bellow is the table with all known Elliott Wave cycles and their corresponding styles of wave numeration.

Note: online trading platforms due to their graphical limitations won't be capable of drawing circles around your wave numbers, so instead of circles traders use square brackets [ ] to label waves: [1], [2] etc.


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