Elliott Wave Theory
Candlefocus EditorThe theory suggests that markets move in waves which unfold in a repetitive and progressive manner with each wave containing one or more sub-waves. It is named after Ralph Elliott, who published his findings in the book "The Wave Principle" in 1938. According to Elliott Wave Theory, stock prices move in five-wave and three-wave patterns, with the former representing a trend of higher highs and higher lows, and the latter representing a trend of lower lows and lower highs.
Generally, each wave subdivides into a five-wave impulse or a three-wave corrective pattern. In the five-wave impulse pattern, the first wave is followed by a corrective three-wave pattern and the second wave then follows. This pattern continues until the fifth wave, at which point the cycle is assumed to be complete. The three-wave corrective pattern is typically composed of two corrective waves followed by a confirmatory wave.
The Elliott Wave Theory is used to identify trends in all financial markets and is based on the notion of “social mood” – that is, the collective psychological state of investors at a given time, which will lead the market to move in a specific direction. According to this theory, the market exhibits the same basic characteristics and will move in the same direction as individual investors.
The Elliott Wave Theory has become an important technical analysis tool used by many traders and investors as part of their decision-making process, and is also used by some fund managers. As with any form of technical analysis, it is important to use other methods in combination with the Elliott Wave Theory to make sure that trading decisions are based on an informed, well-rounded strategy.