Elliott Wave Theory is a technical analysis used to predict stock market trends by monitoring price wave patterns and collective psychology. It divides waves into impulse waves and corrective waves, which repeat in cycles of different time scales. It works on probabilities and is a careful and mathematical way of exploiting the odds in favor of investors.
Elliott Wave Theory, or Elliott Wave Principle, is a type of technical analysis used to predict trends in stock markets. It does this by monitoring unique features in price wave patterns and collective psychology. It is based somewhat on the Dow Theory, which states that the market tends to go up if one of its averages is higher than a previous major high, and therefore the market trend flows in waves of ups and downs.
In 1938, Ralph Nelson Elliott (1871–1948) published his book The Wave Principle, in which he first presented his idea that instead of chaotic waves, the market circulates in a rhythmic pattern, allowing accurate predictions for the future. future. Until Elliott’s time, investors had noticed that external events did not seem to have a consistent effect on the progress of the stock market, leading those investors to conclude that the outside world has no influence on market cycles. Elliott had noticed that investor psychology fluctuates between optimism and pessimism in recurring, rhythmic patterns and theorized that this is the real driver behind market trends.
Elliott wave theory divides waves formed by large highs and lows into two sets: impulse waves, which are made up of five smaller waves, and corrective waves, which are made up of three. On a smaller scale within the impulse wave, these five wave patterns can be found again along with the three corrective waves, and this pattern continues to repeat itself to infinity. By analyzing patterns in current and past trends, an investor can predict where the market will go next or when it is most likely to turn with impressive accuracy.
Each of these sets of five movements and then three movements completes a cycle, categorized by Elliott Wave Theory to define different time scales. Grand Supercycle is the longest Elliot Wave category, spanning several centuries. Next is the Supercycle, or Kondratiev wave, which lasts between 40 and 70 years.
The next category is simply called a Cycle, and it generally lasts from one to several years, although it can last for decades under certain circumstances. A cycle that spans a few weeks or months is called a Primary, and a Minor lasts only a few weeks at most. A Minute represents a few days, a Minuette lasts a few hours, and a Subminuette lasts only a few minutes.
The way Elliott Wave theory works to make accurate predictions can be seen in a simple example. If an investor looks at the last wave of Primary, he will see the particular pattern present during those few years. Finding that pattern, the investor can increase the size of the scale and, using the same pattern, can determine when the next cycle will occur. By increasing the size of that scale, the investor will have an accurate prediction of the ups and downs of market trends for the next 40 to 70 years. Elliott wave theory works on probabilities, so it’s not necessarily a guarantee of what will happen, it’s just a very careful and mathematical way of exploiting the odds in favor of investors.
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