The Elliott Wave Theory is a theory that Ralph Nelson Elliott developed. You can use the Elliot wave to try and predict stock market moves, commodities, forex currency pairs and other assets. However, this theory is not without critics who argue it is not accurate enough for high-frequency trading or short-term forecasting. However, the theory users agree that there are some aspects of the Elliott wave that are useful in predicting markets.
How Does the Elliott Wave Theory Work?
The six main elements of the Elliott Wave Theory can be explained as follows:
- Trends evolve in five waves, with three advancing and two corrective waves forming an A-B-C pattern.
- Wave C always travels against the trend of wave A.
- Wave 3 is typically longer than waves 1 and 5.
- The market alternates between three patterns, motive phase (A-B-C), corrective phase (A-B-C’) and consolidation phase (A-B’).
- Waves retrace between 0.618 – 0.786 the length of waves 1 to 3.
- Trends can never extend beyond the length of waves 1 to 3.
What Makes This Theory Useful?
While it may not be accurate enough for short term prediction, the theory works quite well for predicting medium to long term trends in financial markets. It can be helpful because this allows you to plan your trading with more certainty.
Understanding how the theory works can help you identify possible reversals, trend changes and support and resistance levels.
It gives you a better understanding of where you should place your trades to make profits when the market moves in that direction.
The Elliott Wave Theory may not be 100% accurate, but it can certainly benefit when used alongside other predicting stock market moves. You can test this theory on the Saxo capital markets.
What Risks are Involved when Using the Elliott Wave Theory?
The most significant risk when using this theory is that you will get caught up in the hype and begin to place too much faith in it by entering trades because of signals generated by the theory. It could result in you missing good opportunities because you are waiting for a signal that never comes or holding onto a trade just because you have been told the market direction will reverse.
Understanding what makes this tactic useful and what risks come with using it will help your trading by giving you a better trading plan and avoiding the most common pitfalls.
Why is the Elliott Wave Theory Useful?
The theory can be used as guidance but not for a complete prediction of markets. It is said that it cannot provide accurate signals if we deal with high frequency or short term trading strategies.
Another potential disadvantage of this theory is that it does not have its pattern indicator, so traders need to apply other tools to overview their market position.
If applied correctly, however, this method may give users the ability to understand market trends. It helps investors or traders to generate long-term strategies or at least have the capacity to assess the plausibility of specific price movements over time.
The Elliott Wave Theory is based on a five-wave formation that usually alternates with three corrective ones to form an A-B-C pattern. The first wave is always the longest one, while the third one is the shortest. Wave 2 usually falls in between these two extremes. Three examples of this are impulse waves, diagonal triangles and flat correction patterns. Wave 3 should be longer than waves 1 and 5, although it still has to respect Fibonacci ratios of 0.382 or 0.618 of wave 1, which indicates how much smaller wave five should be compared to wave 3.
The Elliott Wave Theory can be very useful in giving you an insight into the market’s likely future movements. It is not always correct, though, and no trader should base their decisions on it alone. When using this theory, you need to understand what makes it useful, any risks involved when using it and how to use it correctly so that it reflects your trading strategy.