Introduction To Elliot Wave Theory
The Elliott Wave Theory was developed by Ralph Nelson Elliott during the 1930s. Elliott held the belief that although the crypto markets were thought to behave in a chaotic and random manner, that they actually trade in repetitive patterns. We will be looking at the history of the Elliot Wave Theory in this article and how it can be applied to trading.
It was proposed by Elliott that financial price trends resulted from the predominant psychology of investors. He found that when there were swings that occurred in mass psychology that they showed up in the financial markets as "waves" or the same recurring fractal patterns.
Elliott's theory resembles the Dow theory somewhat in that both of the theories recognize stock prices as moving in waves. However, since Elliott also recognized that the markets have a "fractal" nature, he was able to break this down and also analyze it much greater detail. A fractal is a type of mathematical structure, that infinitely repeats itself on an ever-smaller scale. Elliot discovered that price patterns for the stock index were structured this way as well. He started looking at how the repeating patterns might be used as a type of predictive indicator for market moves in the future.
Predicting The Market On The Basis Of Wave Patterns
Detailed stock market predictions were made by Elliot based on the reliable characteristics that he discovered as part of the wave patterns. Impulse waves, which travel in the same direction that the larger trend does, shows five waves every time in its pattern. On the other hand, corrective waves travel in the opposite direction that the min trend. Within each impulsive wave, on a smaller scale, five waves can be found again.
The nested pattern repeats itself at ever-smaller scales ad infinitum. Elliott discovered the financial markets' fractal structure during the 1930s. However, it was only decades later when fractals would be recognized by scientists and when they were mathematically demonstrated.
When it comes to the financial markets, there is the say "what goes up, has to come down." This refers to when a price movement is down or up it is always followed by the opposite movement. Price action is divided into corrections and trends. The main price direction is shown by trends, while corrections move against trends.
Basics of Elliott Wave Theory For Crypto
The following is an interpretation of Elliott Wave Theory:
There are five waves moving in the same direction that the main trend does, and then this is followed up by three waves that are in a correction (which is a total 5-3 move). The 5-3 moves become two subdivisions of the move of the next higher wave.
The 5-3 underlying pattern stays constant, although each wave's time span might vary.
Let's check out a chart that is comprised of eight waves (five net up with three net down) that are labeled 1-6 and A-C.
An impulse is formed by Waves 1-5, and a correction is formed by the A, B, and C waves. The five-wave impulse then forms wave 1 at the next-highest degree, and wave 2 is formed by the three-wave correction at the next-highest degree.
There are usually three distinct price movements in the corrective wave - two in the same direction as the main correction (A and C) and then one against it (B). In the above picture, Waves 2 and 4 are corrections.
In the picture, the waves A and C are moving in the trend's direction at one-larger of a degree. Therefore, they are impulsive and comprised of five waves. In contrast, Wave B is counter-trend and therefore is corrective and comprised of three waves.
An Elliott wave degree is formed by an impulse-wave formation, that is then followed up by a corrective wave that consists of trends and countertrends.
Five waves don't travel net upward always, and three waves don't travel net downward always. For example, whenever the larger-trend happens to be down, the five-wave sequence is as well.
Nine degrees of waves were identified by Elliot. From smallest to largest, he labeled them the following:
Since Elliott's waves form a fractal, theoretically wave degrees continue to expand ever-smaller and ever-larger than those that are listed above.
To use this theory in regular trading, a trader may identify an impulse wave that is upward-trending, go long and then short the position or sell as the five wave patterns complete and there is an imminent reversal.
Popularity Of The Theory
The Elliott Wave principle increased in popularity during the 1970s through the work done by Robert Prechter and A.J. Frost. In their now-famous book the Elliott Wave Principle: Key To Market Behavior, the 1980s bull market was predicted by the authors. Later Prechter issues a sell recommendation just days before the 1987 crash.
The Bottom Line
Practitioners of the Elliott Wave stress that just because the market is in the form of a fractal doesn't mean that it is easy to predict. A tree is recognized by scientists as a fractal, but that doesn't mean anybody can predict the path that each branch will take. When it comes to the practical application of the theory, there are devotees to the Elliott Wave Principle, and like all other analysis methods, it has its detractors as well.
One key weakness that practitioners always can blame on the charts being misread instead of the theory having weaknesses. Failing that, the amount of time that it takes for a wave to complete is always open to interpretation. That said, there are traders who are committed to the Elliott Wave Theory and defend it with a passion.
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