The Elliott Wave principle is a technical analysis of stock and commodity markets, based on charting market cycles using behavioral economics. It divides market cycles into Impulse and Corrective Waves, with further wave structures. The theory is reliable and still widely accepted today, and was formulated by Ralph Nelson Elliott in the 1930s.
The Elliott Wave principle is a form of technical analysis of the performance of the stock and commodity financial markets as opposed to the equally used method of fundamental analysis of the value of a company. Technical analysis relies on gathering data on actual fluctuations in a security’s price as a way of predicting future behavior. Fundamental analysis relies on economic factors that determine a company’s net worth, such as its level of capitalization, price-to-earnings ratio, and so on. Ralph Nelson Elliott, career accountant, is credited with formulating the Elliott Wave principle in the 1930s. He used his understanding of crowd psychology and social trends, known today as behavioral economics, to chart the market cycles of rising and falling stock price structures.
Proponents of the Elliott Wave principle divide it into two types of market cycle waves, known as Impulse Wave and Corrective Wave. These are further divided into finer wave structures, with five for the impulsive wave and three for the corrective wave. Waves follow a fractal pattern regardless of the time frame over which they are being examined, meaning that the chart for a yearly trend for a stock will look a lot like the same chart for an hourly trend for the same stock when using Elliott Wave calculations.
The market trends predicted by the rules of the Elliott Wave principle are quite simple and logical. For example, for a rising stock, wave count rules state that wave two should not break below wave 1 and wave three should not be the shortest wave between waves one, three and five. Nesting these rules into further rules makes the Elliott Wave principle quite reliable. Method traders rely on a general principle that trends indicated by three forms of Impulse Waves and six forms of Corrective Waves are conclusive evidence of a stock’s direction.
Ralph Elliott employed a long and detailed study of stock trends for 75 years until he felt confident enough to publicly release the elements of his theory at the age of 66. He first published it in his own book, The Wave Principle, in 1938, at the age of 67. The Elliott Wave principle is still widely accepted as legitimate today, and Elliott was considered something of a renaissance man in his time. The US government thought so highly of his accounting skills that he was named Nicaragua’s chief accountant by the US State Department. His experiences in Central and South America led to such important results as the financial development policies adopted by the World Bank.
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