What are the basic principles of Elliott Wave Theory?

  

Elliott Wave Theory is based on the idea that financial markets move in repetitive cycles or waves influenced by collective investor psychology. Here are the basic principles of Elliott Wave Theory:

 

1. Wave Patterns:

   - Impulse Waves:
     - These waves move in the direction of the main trend and consist of five waves: three in the direction of the trend (waves 1, 3, and 5) and two against the trend (waves 2 and 4).
   - Corrective Waves:
     - These waves move against the main trend and consist of three waves: two in the direction of the correction (waves A and C) and one against it (wave B).

 

2. Wave Structure:

   - Impulse Wave Structure:
     - Wave 1: The initial movement in the direction of the trend.
     - Wave 2: A corrective wave that retraces a portion of Wave 1.
     - Wave 3: A powerful wave that moves further in the direction of the trend. Often the longest and strongest wave.
     - Wave 4: Another corrective wave, retracing part of Wave 3.
     - Wave 5: The final wave in the direction of the trend, often characterized by reduced momentum.
  

 - Corrective Wave Structure:
     - Wave A: The first wave against the main trend.
     - Wave B: A corrective wave that retraces part of Wave A.
     - Wave C: The final wave in the correction, usually matching the length of Wave A.

 

3. Wave Degrees:

   - Waves exist in a fractal structure, meaning that smaller waves make up larger waves, and larger waves can be divided into smaller waves. Elliott identified nine degrees of waves, from the smallest "subminuette" to the largest "grand supercycle."

 

4. Wave Rules:

   - Rule 1: Wave 2 never retraces more than 100% of Wave 1.
   - Rule 2: Wave 3 cannot be the shortest of the three impulse waves (Waves 1, 3, and 5).
   - Rule 3: Wave 4 does not overlap with the price territory of Wave 1, except in special cases of diagonal triangles.

 

5. Guidelines and Fibonacci Relationships:

   - Waves often adhere to Fibonacci ratios, which are used to predict the length and duration of waves. For instance, Wave 2 might retrace 38.2% or 61.8% of Wave 1, and Wave 3 might extend to 161.8% of Wave 1.

 

6. Wave Personalities:

   - Each wave within an Elliott Wave pattern is said to have its own "personality," which helps in identifying the wave structure:
     - Wave 1: Often hard to identify and looks like a rebound.
     - Wave 2: Seems like a pullback but doesn't retrace beyond Wave 1.
     - Wave 3: Usually the most powerful and extended wave.
     - Wave 4: Often a complex correction, typically taking more time than Wave 2.
     - Wave 5: Final push in the trend, often characterized by weakening momentum.
     - Wave A: The first wave of a correction, indicating a trend change.
     - Wave B: Often seen as a "trap," making the market look like it's resuming the previous trend.
     - Wave C: Usually as strong as Wave A and concludes the correction.

 

7. Alternation Principle:

   - Waves 2 and 4 tend to alternate in form. If Wave 2 is a sharp correction, Wave 4 will likely be a sideways correction, and vice versa.

 

8. Extensions:

   - One of the impulse waves (often Wave 3) tends to extend, meaning it is longer than the other two impulse waves. An extended wave consists of a smaller set of five waves.

 

9. Truncation:

   - Sometimes Wave 5 does not move beyond the end of Wave 3. This is known as a truncated fifth wave and indicates a weakening trend.

 

10. Triangles:

   - A triangle is a corrective pattern consisting of five waves moving against the main trend, labeled A-B-C-D-E. Triangles typically occur in Wave 4 or in Wave B of an A-B-C correction.

 

Conclusion
Elliott Wave Theory offers a detailed and structured approach to analyzing market trends and predicting future price movements. By understanding and applying these principles, traders can identify potential trading opportunities and manage risks more effectively.

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