Ralph Nelson Elliott developed the in the late 1920s by finding that stock markets, presumed to behave in a somewhat chaotic fashion, in fact, did not. They exchanged in repetitive cycles, which he found were the emotions of investors as a reason for external influences, or paramount plogy of the masses at the moment. Elliott said that the upward and downward swings of this mass plogy constantly showed up at the same repetitive patterns, which were subsequently broken up into patterns that he termed waves.
The theory is somewhat depending upon the Dow Theory inasmuch as the price movements move in waves. It was known by the technicians at the time that because of the fractal nature of the markets, Elliott managed to divide and examine the markets at considerably greater detail.
Elliott managed to see unique qualities of wave patterns and also make detailed market forecasts based on the patterns he identified. Fractals are mathematical constructions, which in a ever-smaller scale greatly repeat themselves. The patterns which Elliott found are constructed in the same manner. An impulsive wave, which goes with the principal tendency, always shows five waves in its pattern. On a smaller scale, within each of the impulsive waves of this before-mentioned impulse, five waves may again be found. In this more compact pattern, the same pattern repeats itself ad infinitum. All these ever-smaller patterns are tagged as distinct wave levels in the Elliott Wave Principle. Only much later were fractals recognized by scientists.
From the financial markets we know that each action creates an equal and opposite reaction for a price movement up or down has to be followed by a contrary movement. Price action is broken up into trends and corrections or sideways movements. Trends reveal the main direction of prices while corrections proceed contrary to the trend. Elliott tagged these impulsive waves and corrective waves.
The interpretation of this is as follows: Each action is followed by a response. You will find five waves at the direction of the primary trend followed by three corrective waves (a 5-3 move). A 5-3 move completes a cycle. This 5-3 move then becomes two subdivisions of another higher 5-3 wave. The underlying 5-3 pattern stays constant, although the time span of each may vary. Let us have a look at the next chart made up of eight waves (five up and three down) which can be labeled 1, 2, 3, 4, 5, a, b and c.
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You can observe that the three waves at the direction of this trend are all impulses, so these waves also have five waves. The waves against the tendency are all corrections and are composed of three waves.
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From the 70s, this tide principle gained popularity throughout the work of Frost and Prechter. They published a legendary novel on the Elliott Wave, qualified http://www.fxfisherman.com/forums/. Within this novel, the authors called the bull market of the 1970s, and Robert Prechter called the crash of 1987.
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The corrective wave formation generally contains three, in some cases five or more, different price movements, two at the direction of the main correction (A and C) and one against it (B). Waves 4 and 2 in the above picture are corrections. These waves have the following structure:
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Note that the waves A and C go in the direction of this shorter-term trend, and therefore are impulsive and composed of five waves, and this is shown in the image above.
An impulse-wave formation followed by a corrective wave, shape an Elliott wave degree, consisting of trends and countertrends. Although the patterns pictured above are bullish, the same applies for bear markets, where the principal trend is down.
The has delegated a series of groups to the waves in order of the largest to the smallest. They're:Grand Supercycle Supercycle Cycle Main Intermediate Minor Minute Minuette Sub-Minuette To use the theory in everyday trading, the trader determines the main tide, or supercycle, goes long and subsequently sells or shorts the place since the pattern runs out of steam and a reversal is distinguished.