Having become one of the main tools for analyzing the market situation in the stock market, Elliott Wave Theory has also become widespread among traders working in the foreign exchange market.
The main reason for the high interest of forex traders in wave analysis was its fundamental principle, described by Ralph Elliott in his book The Principle of Waves, published in 1938.
THE ESSENCE OF WAVE THEORY
Leaving the work of a financier due to illness in the early thirties of the last century, Ralph Nelson Elliott paid special attention to the stock market, achieving significant success in concluding contracts to change the value of the Dow Jones index.
And first of all, he succeeded due to the fact that he revealed one very important pattern: the cyclicity of the repetition of events created by the “crowd”.
As Elliott himself noted, those instruments that are least affected by fundamental facts emanating from a single center are subject to this cyclicality. That is, in his opinion, trading in individual stocks was less suitable for the application of wave theory than a composite index.
Thus, we can notice that decentralized cryptocurrency assets are best suited to the description of the type of assets subject to wave analysis.
Ralph Elliott’s observations on the work of wave theory in the decentralized market confirm its wide application since 1971, when currencies were sent into free float at the Bretton Woods Conference, until early 2009, when for the first time since the abolition of the gold-currency standard, the exchange rate switched to manual control by central banks.
At the same time, traders in the stock market working with numerous indices, such as: Dow Jones, S&P 500, NASDAQ, RTS and others, actively apply wave analysis.
INTRODUCTION TO WAVE ANALYSIS
The topic of wave analysis is quite extensive. To study it, entire faculties have been established in the United States and Europe to study the cyclical behavior of the “crowd” in financial markets. But we will try to convey the meaning and main postulates of this type of market analysis within the framework of this article.
One of the basic rules of technical analysis that history repeats is most likely taken from Elliott Wave Theory. After all, within the framework of wave theory, protracted growth cycles are replaced by price fall cycles, forming waves. And for these cycles, Elliott revealed a number of patterns that formed the basis of his view of the market.
REGULARITIES OF WAVE THEORY
Impulse is an upward movement accompanied by an increase in price in the analyzed time period.
Correction is a downward movement accompanied by a fall in price in the analyzed time period.
The higher the period, the stronger the trend – absolutely all textbooks on technical analysis of the market speak about this principle. It implies that if you see a fall on the H1 timeframe and growth on the D1 period, the upward trend has more strength than the downward trend.
The trend tends to change – this means that sooner or later there comes a moment when growth is imperceptibly replaced by a fall, and vice versa.
All these patterns can be clearly tracked on the price chart, dividing it into wave movements.
COMPONENTS OF WAVE MOVEMENT, ACCORDING TO ELLIOTT’S THEORY
- Pulse waves – standard wave motion, according to theory, consists of five main and three reversal waves. Thus, it is customary to consider waves under numbers 1, 3 and 5 as impulse, which are the forming force of the trend.
- Correctional waves – waves 2 and 4 are downward cycle waves that give correction in the market.
- Reversal waves – according to theory, they are marked with the letters A, B, C. These waves appear on the chart as a result of the complete formation of the main 5-wave motion, which is considered complete and usually precede the reversal of the trend.
- At the same time, according to the theory, the waves on the graph are not built in a chaotic order, but are formed according to strictly defined rules.
RULES FOR THE FORMATION OF ELLIOTT WAVES
Waves move from level to level.
- Waves in a larger time period absorb waves of smaller periods.
- The first wave is not suitable for opening deals.
- The second wave is no more than 50% of the length of the first wave.
- The third wave is the best moment to enter the market.
- The length of the third wave is one and a half times the length of the first one.
- The fourth wave cannot fall below the top of the first wave.
- The fifth wave indicates the end of the trend.
SEPARATELY ON WAVES A, B, C
As we noted above, waves A, B, C are reversal. They appear exactly when the 5-wave trend formation cycle is coming to an end. That is why these waves are always part of such reversal figures of technical analysis as “head and shoulders”, “double top”, “failed scope”.
But not always the completion of the trend, accompanied by waves A B and C, is the predecessor of the reversal. In addition to the fact that these waves can be part of reversal figures, they are quite capable of forming such figures of continuation of the trend as the “triangle”.
And in conclusion, I would like to note that Ralph Nelson Elliott’s wave theory is very easy to learn and contains clear and understandable rules that allow even novice traders to easily achieve their goals in decentralized markets.
The fifth wave indicates the end of the trend.