Elliot wave analysis is a means of predicting the direction of currencies, enabling to reduce risk and maximize returns. Formulated by Ralph Nelson Elliott in the early 1930s, the Elliot Wave theory established that the market moves in repetitive cycles in the pattern of waves, based on mass psychology. This theory laid the foundation for Elliot Wave analysis, a form of technical forex analysis, which entails identifying and analyzing repetitive wave patterns.
Elliott Wave Analysis: The Wave Pattern
Elliott wave theory categorizes market behavior into a repeating sequence of eight waves, comprising of 5 impulsive waves and 3 corrective waves.
Wave 1: At this stage, the market is on the verge of becoming bullish, resulting in speculations of an upward movement of prices. This wave is the weakest of all impulsive waves, as the swing here is not very intense.
Wave 2: Moving in the opposite direction of Wave 1, this wave corrects the market movements resulting from Wave 1. However, the pullback at this stage will never go below the origin of Wave
Wave 3: The longest impulse wave, Wave 3 begins very slowly and moves above Wave 1 gradually. The strongest impulse wave, during this phase the prices rise and the market becomes bullish steadily.
Wave 4: A strong rally increases selling in the market; and therefore, Wave 4 moves in the opposite direction of Wave 3, causing a pullback or correction. Again, the pullback will not go below the origin of Wave 3.
Wave 5: This is the last wave in the dominant trend. At this phase, the prices rise to a moderate level.
Wave A: On this wave, the market starts to turn bearish, though it may be considered bullish.
Wave B: During this phase, the prices rise. However, the rise is inadequate to offset the downturn of Wave A.
Wave C: The last wave in the corrective trend, during this phase prices lower, increasing bearish sentiments in the market.
Using Elliott Wave Analysis for Forex Trading
Elliott wave is observed over small timeframes, such as minutes, hours and days as well over large timeframes, which may be as high as decades. Therefore, time is a key parameter of Elliot wave analysis,which makes the theory an exercise of probability. By identifying the probable timeframes of each wave, a forex trader can plan the ‘best’ moves within each wave. Therefore, Elliott wave analysis helps to spot the highest possible moves with the least possible risk.