Elliot wave theory




Waves 1, 3 and 5 represents bullish investor sentiment or the impulse wave. Waves 2 and 4 are corrective waves fueled by profit takers or short sellers, at the peak of the 5th wave comes a major bearish wave labeled A and C while B is a minor trend reversal caused by investors with a little hang over from that strong bull market picking up false bottoms.

Markets are somewhat chaotic when looking at the charts they produce, they can go up in a second and then fall dramatically the next as if it can't be tamed and just goes at random directions like a ricocheting bullet across a room full of pipes. However, these random movements are actually caused by human emotions. Nobody could stay at an extreme emotional state for so long and it will eventually go back to normal, If that is the case, then markets should have a pattern since it is associated with human emotion. This is what Ralph Nelson Elliot observed that led him to the development of the Elliot Wave Theory. His theory states that markets does not behave in a chaotic manner but instead, they follow a pattern in accord with the dominant psychology of the people who moves them based on a relevant event.

Elliot stated that a trend whether up or down, consists of 5 alternating waves headed in one direction and 3 alternating waves going in the opposite direction which completes a cycle. A wave headed upwards are called motive or impulse waves while a downward trending wave is called a corrective wave. Each completed cycle would form a wave which is a part of a much bigger cycle. The order of scale of these cycles starts from the smallest series of waves called a sub-minuette, followed by Minuette, Minute, Minor, Intermediate, Primary, Cycle, Supercycle and then the Grand supercycle.

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