The Elliott Wave theory represents a development of the well-known Dow theory. It applies to any freely traded assets, liabilities, or commodities (stocks, bonds, oil, gold, etc.). The Wave theory was proposed by an accountant Ralph Nelson Elliott in his book “The Wave Principle” published in 1938. Elliott Wave Theory is based on some constant cyclical patterns in the psychology of human behavior. According to Elliott, the market price movements can be clearly determined and shown on the chart as waves. Here, a wave is a clearly visible price movement. Elliott Wave Theory is a system of empirically deduced rules for predicting market’s behavior.
Within a bullish trend, waves 1, 3, and 5 are impulse waves, which are subdivided in five smaller-degree waves. Waves 2 and 4 are corrective waves, and they are subdivided into three sub-waves. The impulse waves are marked by numbers, while corrective waves – by letters.
For all time frames, Elliott theory states:
1. The market can be in either a bullish or bearish phase.
2. Both phases in the chosen time frame can be described by 8-wave formation of market movements.
3. The first five waves of any phase, which are marked by numbers, form the main market trend, or impulse. The last three waves, which are marked by letters, form the correctional movement that is opposite to the main trend. The further development within the last three waves can lead to a change in the market trend.
4. Each wave develops in time according to its own rules. The moment when the wave completes its formation, as well as its size, can be predicted with high accuracy, given that all market waves on a bigger time frame have been correctly identified, and the current market condition has been accurately determined.
5. If the predicted moment of the wave’s completion or its size does not correspond to earlier calculated values, this means that the initial analysis of Elliott waves was not correct.
Elliott waves rules:
1. Wave 2 never retraces more than 100% of Wave 1. For example, within a bullish trend, the low of Wave 2 will never move below the level where the Wave 1 started.
2. Wave 3 cannot be the shortest of the three impulse waves. Usually it is the longest wave.
3. Wave 4 does not overlap with the price territory of Wave 1, except for a special chart formation. The market movement remains the same as before the wave was formed, regardless of its size and movement period.