As part 1 we mentioned to you Dow Theory, this is considered the basic principle for the birth of all technical analysis methods. But next, let’s dive into the specific analysis of the cycle structure of the price trend and the theory that Primexbt
wants to talk about can only be Elliott Wave- An important technical analysis tool that no trader knows. can be overlooked.
1. The History of the Elliott Wave Theory
Elliott wave theory is a detailed description and behavior of groups of people. It shows how the crowd psychology changes from pessimism, distrust, abandonment to optimism, hope, excitement and vice versa in a natural way forming distinct patterns that can be measured.
The Elliott wave theory was discovered by an American professional accountant named Ralph Nelson Elliott (July 28, 1871 – January 15, 1948). It took him a lot of time analyzing historical stock data for many years to come to the conclusion that stock market movements can be predicted by observing and identifying repeating wave patterns. repeat.
Mr. Elliott describes that one of the most obvious places to observe this phenomenon is in financial markets where investor sentiment changes constantly and is recorded in the form of price movements. Elliott distinguished 11 price movement patterns, also known as wave patterns. He named, defined, and illustrated these patterns. He describes how patterns are formed and their larger versions. The Elliott Wave Theory is a collection of price patterns and possible position interpretations in the overall development of the market. The market often follows development periods, alternately following growth, decline, and non-growth phases, and builds segments according to similar patterns of increasing size. And from that market data can predict the new trend of the market in the next time.
In 1938, Elliott first published his theory of market patterns in a book titled The Wave Principle. In 1939, he summed up the wave theory in a series of articles in the Financial World magazine. Finally, in 1946, Elliott addressed wave theory most comprehensively in his last major work, Nature’s Laws: The Secret of the Universe.
Later wave theory was not only applied to stock market analysis, but also widely used in other financial markets, index markets, commodities, currencies, Crypto markets, Forex markets Is no exception.
2. Elliott wave pattern structure
According to the Elliott wave theory, in the main trend (main trend) the financial market it moves in a 5-wave pattern and continues with 3 corrective waves (maybe 3 or 5 waves) before turning back. mainstream trend.
The main waves are marked in the order 1-2-3-4-5. Corrective waves are marked with the letter a-b-c(-d-e). In different levels, the main wave and the correction wave often alternate and this is called a wave within a wave. A large wave is made up of many small waves. The big wave period includes many other small wave periods.
An impulse wave consists of 5 lower waves and moves in the same direction as the trend of the higher wave.
A corrective wave always consists of 3 lower waves and moves in the opposite direction of the trend of the higher wave.
In an Elliott wave pattern, the major and corrective waves alternate at all levels of the trend, in all time scales.
The Three Rules of Elliott Waves
A valid Elliott wave pattern must adhere to the following 3 rules:
1. Wave 2 does not retrace after the start of wave 1.
2. Wave 3 is not the shortest of the main waves 1-3-3.
3. Wave 4 did not break the price zone of wave 1.
Wave within wave in Elliott wave theory
Following the illustration below shows the structure that forms the wave-in-wave phenomenon of the Elliott wave theory.
The first link is an impulse wave pattern that ends at peak 1 (wave 1). This pattern shows that the price movement of the larger wave level is also moving up. It also signaled the start of a 3-wave correction, wave 2. Waves 3, 4, and 5 complete the larger host sequence (1).
The main wave structure of wave 1 shows that the price fluctuates in the direction of wave greater than wave (1). The correction in wave (2) followed by wave (3), wave (4) and wave (5) will complete the master wave association of the larger level wave .
Again, a 3-wave correction of the same wave level occurs as wave . So in turn the development completes the whole process.
In any financial market (forex, crypto, indices, commodities…) prices will always follow alternating cycles of ups and downs, meaning that in a major uptrend the market will there are alternating bearish phases and vice versa, this is completely consistent with Dow Theory and now it is true again with Elliott Wave Theory. Therefore, the market’s movements will always fall at 2 opposite phase: the period when the market is confirming the main trend (represented by momentum waves) and the period when the market is correcting that main trend (correction waves).
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3. Elliott Wave Levels
In the above example, after the completion of that largest Elliott wave, there will be another Elliott wave with similar structure and similarity to it, and so on to form an Elliott wave of higher level. In Elliott Wave Theory there are 9 different levels, depending on the time to complete each level, however, all of these divisions are relative. Besides, within the same level, the size and formation time of each wave can also be very different. 9 Elliott wave levels include:
• Grand Supercycle: a time that lasts up to a century
• Super Cycle (large cycle): lasts several decades
• Cycle: lasts from one year to several years
• Primary: from a few months to 1 or 2 years
• Intermediate (intermediate): from a few weeks to a few months
• Minor (small): lasts for a few weeks
• Minute (quite small): lasts for several days
• Minuette: lasts for several hours
• Subminuette: within minutes
Tools for determining price targets and wave amplitudes
The two main tools that are used most effectively to perform this function are the price channel and the Fibonacci.
The price channel consists of 2 trend lines that are parallel to each other and contain almost the entire range of price movements in one wave. In triangle wave patterns, these 2 trend lines are not parallel, but in this situation, we still consider it as a price channel.
This price channel tool is often used to identify waves of the same level, effective in fundamental impulse waves, Zigzag patterns or triangle wave patterns.
While studying the mathematical properties of waves and wave patterns, Ralph Nelson Elliott came to the conclusion about the relationship between Fibonacci and Elliott waves that the Fibonacci sequence is the basis of the Elliott Wave Theory. The key Fibonacci retracement levels appear many times in the Elliott wave structure, including both the fundamental corrective and momentum patterns and in all of their more complex wave patterns.
To calculate the amplitude of the wave, at least the market has formed the first wave, which is wave 1 of impulse waves or wave A of corrective waves.
Wave 1 and A are the base waves, their length and slope will determine the amplitude of the next waves when using Fibonacci.
On the trading software, to determine the amplitude of the dynamic waves (3, 5), we use the Fibonacci Extension, the corrective waves (2, 4) use the Fibonacci Retracement.
Elliott Wave Theory is not a trading technique, so there are no specific rules for determining entry or exit points. Moreover, it is very difficult to predict exactly how the Elliott wave will be structured because it has so many different variations. However, traders around the world still love to use Elliott Wave Theory by combining with other analytical tools that Fibonacci is a typical example, to both determine the next direction of the market’s movement, just determine their volatility range to have the most effective trading direction.
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