So here’s the deal: Ralph Elliott, a math genius and theorist, made waves in the first half of the 20th century. Back in the 1930s, this guy figured out how market trends and social moods are closely connected. He established that market prices move in specific patterns, which we savvy traders now call Elliott waves, or simply waves.
What’s Elliott Wave Theory?
Elliott pointed out that price trends are influenced by the collective behavior of investors. He noticed that shifts in mass psychology emerge in repeating “waves” within our favorite markets.
Now, Elliott's theory kinda resonates with the Dow theory since both suggest that stock prices continuously move in waves. But Elliott took it a step further, breaking down market behavior like an art form. He started analyzing how these recurring patterns could act as a guide for predicting future market trends. For traders looking to dive deeper into market analysis, exploring the comprehensive strategies available on Pocket Option trading platform might provide an insightful edge.
In the trading world, we all know the saying: "what goes up, must come down." Basically, every price rise or fall is followed by the opposite action. Prices move in trends and corrections, where trends set the main pace and corrections move against the trend.
You’ve got five waves moving in the direction of the main trend, followed by three waves correcting it—a neat 5-3 combo. Waves 1, 2, 3, 4, and 5 create an impulse, while waves 2 and 4 are the corrective ones.
Let’s dive into the Wave Theory with an uptrend as our example:
- The first wave is where the excitement begins. Think of it as a price surge that surprises everyone, driven by a big investment in some asset. Predicting this one is tough since it’s the big players driving the trend, while the smaller ones just follow along.
- The second wave is all about correction. This follows after some investors pull back their positions, while others rush to minimize their losses.
- The third wave is the powerhouse. Sellers back out as more buyers jump in, triggering a solid upward movement.
- The fourth wave is, you guessed it, a correction. The major players begin to take profits, sensing that the movement is starting to lose momentum.
- The fifth wave is the risky one. This wave comes from latecomers entering the game, but watch out—this wave can often be a trap as the trend changes direction quickly.
Now, the same scenario plays out in a downward movement, but we’re dealing with three waves instead of five.
How to trade using the Elliott Wave Theory?
It’s a no-brainer that the golden moment for trading is finding the right entry at the start of the third wave formation. To predict when it’ll show up, you gotta analyze the wave structure and figure out where the second wave hits its peak.
For that, here’s what I’m using:
- Two indicators: SMA and moving average.
- Two moving averages, specifically 14 and 21 periods.
- Those reliable Japanese candlesticks.
- Timeframe – aim for 15 to 45 minutes.
More pro tips for trading options using Elliott Wave Theory!
Keep an eye out for the impulse movement that signals the start of the first wave. After some sideways action, the 14-period moving average should cross above the 21-period one. The direction of that crossing? It indicates the trend.
If the trend’s going up, draw a support line and wait for a breakout (marking the second wave’s start). If it’s a downward trend? Just flip that logic around.
For the second wave, set up a resistance line (for uptrends) or a support line (for downtrends).
When that breakout hits, it’s a go for the third wave. Time to grab a contract that aligns with that trend!
Heads up! On my chart, those moving averages need to keep some space apart. If they start getting too close or crossing, then the signal is just noise—no solid trend in sight.
A little reminder: set the expiration time to three candles.
The Elliott Wave community believes that just because the market operates like a fractal doesn’t mean it’s easy to predict. Sure, scientists view a tree as a fractal, but that doesn’t help you guess which way every branch is going to bend. And just like any analysis method, there are true believers in the Elliott Wave Principle and those who maintain a healthy skepticism.
One of the biggest sticking points? Traders often blame their chart reading rather than putting the theory itself under scrutiny. Plus, there’s always that flexible interpretation of how long a wave might take to reach the end. But, I tell you, those who believe in the Elliott Wave Theory defend it with fiery dedication.
