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A Guide to the Elliott Wave Principle

Helps you understand and interpret market movements

Sometime in the 1930s, there was a man who proposed a way of identifying all sorts of future movements in the foreign exchange market; his basis is on market history, likelihood of extreme conditions, and typical crowd psychology. According to him, with the use of a technical indicator and advanced mathematical equations, market trends are recognizable. Since market events, when reviewed thoroughly, reveal a repetitive nature, the analyst can determine price action, as well as various profitable trading opportunities.

Elliott Wave Principle basis

The basic chart that defines the Elliott Wave Principle, used to interpret market movements
("Elliott wave" by Masur - R.N. Elliott, "The Basis of the Wave Principle," October 1940..
Licensed under CC BY 2.5 via Commons)

The man’s name is Ralph Nelson Elliott and he is the genius behind the Elliott Wave Principle.

Elliott Wave Principle 101

The Elliott Wave (or the EW) Principle is famous in the forex market; traders of all skill levels rely on it for the prediction of market direction. It states that upon the analysis of a technical chart, among the significant and identifiable elements are waves; these waves, whether corrective or dominant by nature, are interpretable and come with an indication of succeeding market movements. Undoubtedly, despite the fact that its status as a technical indicator remains theoretical, it is very useful.

Moreover, the Elliott Wave (EW) Principle addresses a concept in behavioral economics and finance that is referred to as heuristics; it suggests that forex market activity is predictable even without using strict logic as basis. Granted that previous trends are given light and market noise is eliminated, an analyst can determine the next upcoming price direction.

Different Trading Approaches

Elliotticians or Elliot Wave Principle analysts are aware that using the indicator can be accomplished in various ways; a popular technique is by waiting until it yields a five-wave count. With proper employment, its reliability is virtually unquestionable and can emphasize market extremes; ultimately, it can reward the information on which market trends are worth following.

Other uses:

  • It can assist in the construction of a trading exit plan
  • It can point out the need for the placement of a stop-loss order
  • It is used as a complementary indicator; it can verify a trend that was originally identified by another indicator
  • It is used to calculate profits

The Importance of Sticking to the Rules

As mentioned, the Elliott Wave Principle is still recognized as a mere theory; its cogency is criticized by a few economists. However, it is known that when certain rules are followed, it does not report misleading trends. Influential factors (e.g. appropriate stop-loss point, attentiveness to the 1st batch of waves, trade signal authenticity), if noted, can enhance the indicator’s reliability.

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