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Introduction

What is the Elliot Wave Theory?

This theory is a popular method of analysis that applies a technical approach with a fundamental analysis interpretation. Elliott Wave Theorists also concentrate on the price action strictly, and agree to the notion that the price is the beginning and end of all analysis, but they recognize that there exists an important relationship between liquidity, credit, and economic robustness which underlies the existing price patterns in the market.

Courtesy of google images and Investopedia

The Elliot Wave Theory

The Elliott Wave Theory is based on the cyclical nature of market events. Most traders are familiar with the fact that market events, and economical conditions tend to recur in time with a varying frequency. A growth phase may be exceptionally long, or a recession or bear market may be surprisingly harsh and deep, but the nature of trading and economic activity ensures that sooner or later the existing conditions will revert to the opposite, toward normal.

Courtesy of google images

Trading the Elliot Wave

Courtesy of Google images

A wave theorist will divide the price pattern into several sub-patterns  and consider trade opportunities on the basis of trends that exist at lower levels. Although Elliott Wave Theory is often discussed in the context of decades or years, the fractal nature of the price action enables the application of the theory at any timeframe.

The Bollinger Bounce

Wave theory divides price action into five main phases. At the first phase, the trend is barely obvious as only a small number of traders are aware of its emerging potential. At phase two, there is a small correction, but it never brings prices below the inception point of the trend. Phase three is the strongest and most powerful, and also drives a large number of bystanders into the price action. Phase four is the ensuing corrective phase, and phase five is the final, bubbling phase of the trend where everyone is pushing in and massive amounts of capital enter the market. Phase five is followed by a collapse which ends the trend.

Trade the Elliot Wave

Courtesy of Google images

Deciding where each of these phases begins or ends is mostly a matter of intuition. As such, there are no generally accepted methods, and each trader will sooner or later improvise his own techniques for determining the time frame of a trend. This is not necessarily a problem, since the best way of coping with the resultant failures and losses is choosing a strategy that will accommodate your risk tolerance and mental resilience in trading. Since each person is different, interpretation of Wave Theory also varies from person to person.

The Bollinger Bounce

Closing Notes

The Wave Theory is useful as a tool for organizing one's opinion about the markets, but it has very little predictive power in the storm of real market action. One could certainly use the theory to generate entry/exit points for trades, but consistent success is only possible if this theory is translated into a well-tested technical set of trading rules.

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