Elliot Wave Theory
Ever heard of the Elliot Wave Theory? Well it does sound somewhat technical doesn't it?
I am here to try and de-mystify it as much as I can
When I discussed technical analysis , I mentioned that investors who use technical analysis subscribe to three main schools of thought - Dow Theory, Elliot Wave theory and Candlestick charting.
This principle is simply about how groups of people behave. It is the basis of any discussions on investor psychology - which when you think about it - this is the core that drives the stock market.
Interestingly, over the years studies shown that the stock market does not react consistently to outside events. In addition charts move in waves.
This theory uses these two observations and the element of probability to determine the likely trend of a stock.
From years of experience it has been determined that a stock will go through two main phases that consist five basic wave structures in the motive phase and three waves in the corrective phase.
Sounds a little confusing - right? Well maybe this diagram should help!
The basics of the Elliott Wave Cycle
I cannot do full justice to this theory on one or two pages.
What I can do however, is provide you with good introductory information that will help you understand.
What I also encourage you to do is read! There is an excellent excellent tutorial about The Elliot Wave Theory presented by Elliot Wave International that I encourage you to read.
Enough introduction - lets talk about waves and phases, and motives and corrections..
The first phase consisting of five waves is what you the investor would be interested in.
Why? because this is your uptrend phase.
Wave One denotes the stock coming off of a previous downtrend and beginning a new uptrend. Wave Two denotes the pull back. When you see this pull back, your goal is to look for an entry point.
Wave Three is where you make your money. You enter a position and go long because as you can see this is the longest wave. In Wave Four there is still some upward movement, but if you notice this is shorter. If you happened to enter during this wave, your profits will be a lot less than if you entered in Wave Three. Wave Five is the wave before the downward trend begins.
Entering a position at this point will not produce as much profits as if you entered in Wave Three.
This marks the end of the motive phase and the beginning of the correction phase..
The correction phase of the wave starts with Wave A which is a downward trend. Investors may see this as a pullback but its not. It is followed by Wave B which does not post a higher high (HH) or even get close to Wave Five's high. Wave C continues this downtrend and for those who short the market - this is an excellent opportunity to do so.
There - you have it!
This is only the basics. Trust me - it can and sometimes does get more complicated that this explanation.
But it has worked for Swing Traders and is therefore worth mentioning.
As always - before you make any trade - do your research!