The Elliott Wave Theory is considered one of the most critical theories on the stock market today. According to the proponents of this theory, market trends can be predicted using Elliott waves, even though this assumption is highly controversial. Nevertheless, investors almost always have at least heard of the Elliott Wave Theory and know what it is.
Here you will learn the Elliott Wave Theory basics!
Elliott Wave Theory: Repetitions on the Stock Market
Through decades of stock market movements on the global stock markets, Charles Dow had concluded that market movements regularly repeat patterns. However, these repetitions are not arbitrary but characterized by specific influences.
Elliott Wave Theory goes into the details of this repetition. Elliott, in his studies known today as the Elliott Wave Theory, examined Dow's findings and came to a similar conclusion. In his research, he came across different patterns of repetition, which occurred not only at longer intervals, such as months or years but also within hours or days.
However, Elliott continued to research and in the following months went in search of the origins of these repetitions. While Dow could only guess at the influence of the human psyche in his research, Eliott deepened his understanding of human behavior.
Elliott Waves: The Wave Principle
According to Elliot's The Wave Principle, published in 1938, the market's fluctuations are based on two investor sentiments: optimism and pessimism. These are responsible for the waveform of stock prices.
According to the Elliott Wave Theory, market movements are divided into trends and countervailing corrections. Trends designate developments in the main direction of a course, while corrections move in opposite directions to the trend.
Action and reaction in the price development
According to the physical law of action and reaction, the courses for a movement also follow a correction in the opposite direction. The general theory is based on a five-part upward wave and a three-part downward wave.
The wave example
Looking at such a development, one sees the following pattern: Wave 1 follows the trend, which in this example moves in a rising direction before a correction movement briefly interrupts the slope (wave 2). Wave 3 and Wave 4 repeat this development before wave five increases again.
After these five parts, the upward wave is now over. A three-part correction wave generally follows this. Wave A and wave C thus fall off in this example - interrupted by a counter-development in wave B.
This must be just a correction. This stops clearly ahead of the course that was reached before wave 1. The general trend continues to point upwards in our example.
Opposite developments possible
Of course, contrary developments are possible, with the primary trend pointing downwards. In general, five-part downward and three-part upward waves are registered.
Every single wave is part of more significant wave motion - but at the same time, it can be divided into smaller sub-waves, which are also built according to the 5 + 3 scheme.
Investors now only have to find out in which wave formation the share price is currently located. In the end, if the steps are followed, the way the theory gives them, you are bound to predict the market trends accurately.