Introduction: To Elliott Wave Theory
The Elliott Wave Theory was developed by Ralph Nelson Elliott during the 1930's (BTW, click here for our overview of the basics of technical analysis if you need that first). 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 Elliott Wave Theory in this article and how it can be applied to trading.
Who was the creator of the EWT?
It was proposed by Ralph Nelson 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.
EWT 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. Ralph Nelson Elliott 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. This fractal in mathematics principle teaches us much about the emotions and sentiments of market rallies, today the Elliott wave theory is used commonly alongside more intricate tools. This is a strong card and provides us a way to always be learning.
Learning to trade market sentiments and finding your style of investment and trading with Elliott wave theory. You will always learn more working and exchanging ideas with others. Join our private community of hundreds of members who are learning to trade and invest their ways to long term financial freedom! Thanks to Ralph Nelson Elliott, we now have this very unique way of recognizing patterns that can create profitable trends in the markets we are trading.
[Note: If you would like to learn more about Elliott wave theory and have lessons and how they apply to the bitcoin and crypto markets be sure to follow the rest of the Arcane Bear Academy Content]
Does the Elliott wave theory work?
Detailed stock market predictions were made by Ralph Nelson Elliot, based on the reliable characteristics that he discovered as part of the wave pattern. 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. We are essentially looking to technical analysis and fundamentals driving this momentum in the crypto or stock market arenas Wave theory is a flexible pattern that when used properly can yield great results for the investor and trader alike.
The nested wave pattern repeats itself at ever-smaller scales ad infinitum. Elliott Wave Theory looks at the financial markets' fractal structure during these time frames and makes conclusions about where we are in the emotional structure of a larger growthpattern. However, it was only decades later when fractals would be recognized by scientists and when they were mathematically demonstrated. Elliot wave theory makes use of determining whether the impulse or corrective wave is currently in play in longer and shorter time frames. Although with ost trading patterns, the larger the time frame the more reliable the data and the pattern breakouts.
Impulse waves VS Corrective Wave Patterns
. As we will get into a little more in detail as we look at what each of these tools for technical analysis of the markets can be used. Impulse waves are real drivers of change and the correctives sit on the backs of those peaks. Often retracing in markets up to 80% on a frequent basis, the understanding and proper recognition of the corrective wave allows us to find opportune times to enter market positions. Whereas the impulse or bull waves are always the markets we want to be selling. The traditional stock market vs cryptocurrency markets so seem to show variation in the Elliott wave principle and its ability to discover sentiment, simply that the crypto markets seem to express a larger, more exaggerated pull to the up and down. We can see why 24/7 a week markets with lowered liquidity and scarcity such as the crypto space create such powerful waves and patterns.
When it comes to the financial markets and technical patterns, there is the saying "what goes up, must 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 the direction of the trend.
Using some of these guidelines and cycle theory, we can now take our investments to the next level by empowering ourselves with the tools needed to recognize market cycle lows and highs more carefully.
How do you use Elliott Wave Theory for trading?
The following is an application of EWT:
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 wave pattern stays constant, Impulsive waves followed by corrective waves, although each wave's time span might vary and the depth and peaks of the highs and lows also 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 waves - 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. Corrective waves can also find complexity here as well, depending on the trading pattern you are aiming at taking advantage of.
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 Elliott Wave Theory:
Since Elliott 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 completely and there is an imminent reversal.
What is the Elliott Wave Indicator and how do I use it?
This principle increased in popularity with technical analysts 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 application of this tool become very common and can be found in every trading software for charting all of your wave counts. Often we are looking to trade waves 1 3 and 5. From there we can find entries or exits based on waves 2 and 4! These patterns are key to keep your eyes on as it can make a huge difference in your trading methodology. What Ralph Nelson Elliott laid down so many years ago is still a very strong principle in the way many traders and technical analysts look at the stock market and its relative asset prices and movements.
Is the Elliot Wave Theory Accurate?
Practitioners of the Elliott Wave structure and principles 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. Finding the proper ration and use of any primary indicators. When we are looking for market trends we do not want to simply rely on an advance point or another. Elliot wave analysis is a great way to create a general sentiment and analysis at a glance for any larger time frame. 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 EWT and defend it with a passion.
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