Elliott Wave analysis is a common technical tool used in trading which is based on crowd psychology and pattern recognition. Below, Elliott Wave International presents some introductory material for learning to use the Elliott Wave Principle in trading.
Trading with Elliott Waves
Ralph Nelson Elliott, who developed the Wave Principle around 70 years ago, theorized that social behavior trends and reverses in recognizable patterns. He then suggested that these patterns often unfold in the financial markets and can be used to anticipate where asset prices will go next.
(But "waves" do not dictate where prices will go. I doubt they play much of a part in longer-term prices of assets, although EWers may disagree. Rather, I believe the patterns are somewhat self-fulfilling, especially in the short term, because many people believe markets will follow the patterns and trade according. Further, a major "shock" to the system — e.g. very bad news, very good news, a merger, etc — can completely disrupt the pattern that you may think you see.)
From The Elliott Wave Tutorial:
In his 1938 book, The Wave Principle, and again in a series of articles published in 1939 by Financial World magazine, R.N. Elliott pointed out that the stock market unfolds according to a basic rhythm or pattern of five waves up and three waves down to form a complete cycle of eight waves. The pattern of five waves up followed by three waves down is depicted in Figure 1-2.
One complete cycle consisting of eight waves, then, is made up of two distinct phases, the motive phase (also called a "five"), whose subwaves are denoted by numbers, and the corrective phase (also called a "three"), whose subwaves are denoted by letters. The sequence a, b, c corrects the sequence 1, 2, 3, 4, 5 in Figure 1-2.
At the terminus of the eight-wave cycle shown in Figure 1-2 begins a second similar cycle of five upward waves followed by three downward waves. A third advance then develops, also consisting of five waves up. This third advance completes a five wave movement of one degree larger than the waves of which it is composed. The result is as shown in Figure 1-3 up to the peak labeled (5).
At the peak of wave(5) begins a down movement of correspondingly larger degree, composed once again of three waves. These three larger waves down "correct" the entire movement of five larger waves up. The result is another complete, yet larger, cycle, as shown in Figure 1-3. As Figure 1-3 illustrates, then, each same-direction component of a motive wave, and each full-cycle component (i.e., waves 1 + 2, or waves 3 + 4) of a cycle, is a smaller version of itself.
Every wave serves one of two functions: action or reaction. Specifically, a wave may either advance the cause of the wave of one larger degree or interrupt it. The function of a wave is determined by its relative direction. An actionary or trend wave is any wave that trends in the same direction as the wave of one larger degree of which it is a part. A reactionary or countertrend wave is any wave that trends in the direction opposite to that of the wave of one larger degree of which it is part. Actionary waves are labeled with odd numbers and letters. Reactionary waves are labeled with even numbers and letters.
In the following clip, Jim Martens explains how learning to use Elliott waves can be as simple as counting to 5 and knowing your A-B-Cs.
In the next two videos, Jeffrey Kennedy explains how using the Wave Principle in trading can help you analyse the market and spot opportunities.
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These articles were syndicated by Elliott Wave International and were originally published under the headlines Trader Education Week: Valuable For Traders At All Levels and Trading with Elliott Waves Doesn't Have to Be Complicated.
