What is Elliott Wave Theory?
Elliott Wave Theory is a technical analysis tool that was developed by Ralph Nelson Elliott in the 1930s. It is a type of forecasting tool that attempts to predict future price movements based on past price changes. Elliott believed that price movements in financial markets are not random, but instead, follow repetitive patterns that he called waves.
The Five Waves
Elliott identified two main types of waves: impulse waves and corrective waves. An impulse wave consists of five smaller waves that move in the direction of the trend, while a corrective wave consists of three smaller waves that move against the trend.
The five waves in an impulse waves are:
Once the pattern is complete, a correction will follow. The correction consists of three waves, typically smaller in extension than the impulse waves, and moves against the trend. The correction usually ends near the end of Wave 4, and prices then continue in the direction of the original trend.
The Fibonacci Sequence
Elliott believed that waves follow the Fibonacci sequence, a mathematical sequence discovered by Leonardo Fibonacci in the 13th century. The sequence consists of numbers where each number is the sum of the two preceding numbers.
In Elliott Wave Theory, the Fibonacci sequence can be used to determine the end points of waves. For example, if Wave 1 is 100 points, Wave 3 is likely to be 161.8% of Wave 1, or 161.8 points. Likewise, Wave 4 may correct to 38.2% of Wave 3, or 61.8 points.
Limitations and Criticisms of Elliott Wave Theory
Elliott Wave Theory can be a useful tool for traders, but it also has its limitations and criticisms. One of the main criticisms is that the theory is subjective and open to interpretation. Elliott Wave Theory is not a mechanical trading system, and different analysts may interpret price patterns differently.
Another criticism of the theory is that it can be difficult to apply in real-time trading situations. Elliott Wave Theory requires the analyst to identify the pattern correctly, which can be difficult when prices are moving rapidly. Want to know more about the topic? Elliott Wave Theory https://marketrightside.com/elliott-wave-theory, we suggest this to improve your reading experience and expand your understanding.
The Bottom Line
Elliott Wave Theory is a popular technical analysis tool among traders and investors. The theory identifies patterns in price movements and attempts to predict future price movements based on those patterns. While the theory can be useful, it is also subjective and open to interpretation, and can be difficult to apply in real-time trading situations.
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