Trade Forex Trading

The Elliott Wave Forex Trading Theory

Elliott Wave Theory/Principle is a form of chart technical analysis that traders and other investors use to forecast trends in the and the currency markets by identifying extremes in investor psychology, highs and lows in prices, & other collective activities. This theory model shows that collective human psychology develops and forms in natural patterns over time, through buying and selling decisions reflected in the market prices.

This theory of analysis was created by Ralph Nelson Elliott that is based on the theory that, in nature, many things occur in a five-wave pattern. These patterns are also applied to analysis, to analyze & interpret the behavior of market trends using the theory.

When this theory is applied to Forex, the assumption is that the market price will move in a pattern of five waves - three up moves, numbered 1, 3 and 5 - that are separated by two down moves, number 2 & 4. When the three upwards moves (1, 3, 5) are combined with the two downwards moves (2, 4), they form the 5 Wave Elliott pattern.

The trading theory further holds that each five-pattern up-move will be followed by a down-move also consisting of a three-pattern down moves - this time, 3 down ones aren't numbered but use the letters A, B & C. So as to differentiate them from the 5 ones for the up move.

5 and 3 Wave Pattern

Main trend will comprise of 5 moves while the market retracement will comprise three moves.

Five setup (dominant trend) - uses 1, 2, 3, 4, 5

3 setup (corrective trend) - uses A, B, C

Elliott Wave Theory Explained - Five and Three Elliot Count - How Do You Trade Using Elliot Wave Theory?

This article is about how to trade online currency exchange markets using the Elliott Theory as the driving force of currency pairs. This trading model relies heavily on looking at price charts. Technical analysts use this theory to study developing trends to identify the waves & discern what prices might do next.

By analyzing these patterns on a chart & applying the Elliott Wave Theory, traders are able to decide where to get in and where to exit by identifying the points at which the price is likely to turn.

One of the easiest places to see this theory at work is on the market, where the changing investor psychology is recorded in the format of price movements. If a forex trader can identify the repeating patterns in prices, & figure out where these repeating pattern is in relation to Elliott setup counts then the trader can predict where prices are likely to head to.

Rules for Elliott Wave Count

Based on the market patterns occurrences formed by this theory, there are several guidelines and rules for valid Counts:

  1. Wave 2 shouldn't go below the starting of Part 1.
  2. Wave 3 should be the biggest among Part 1, 3 & 5.
  3. Wave 4 should not over-lap with Part 1.

Five setup (dominant trend)

Elliott Wave Analysis Theory - Five Wave Setup Count Main Trend

1: This one is rarely obvious at its inception. When the first wave of a new bull market starts, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their estimates lower: the starting of a new trend probably doesn't look strong. Sentiment surveys are still bearish & the implied volatility in the market is high. Volume might increase a bit as prices rise, but not by enough to alert many trading analysts.

2: This one two corrects 1, but can never extend beyond the beginning point of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" mentality reminds all that the bear market is still in place. Still, some positive signals appear for those that are looking: volume should be lower during 2 than during 1, prices usually and generally don't retrace more than 61.80 % of 1 part one gains. Price will get to a low that's higher than the previous and prior low resulting into a higher low.

3: This is generally the largest & most powerful move upwards, larger than 1 & 5. News is now positive and fundamental analysts start to raise estimates. Prices rise quickly, corrections are short-lived & shallow. Anyone looking to get in on a pull back will likely miss the boat. As 3 starts, the news is probably still somewhat bearish, and most of the traders still remain negative: but by part 3 midpoint, the crowd will often join in and agree that the new sentiment of the market is bullish. Wave three will extends beyond the highest level reached by 1.

4: This is typically & clearly corrective. Prices might move sideways for an extended period, & 4 mostly retraces less than 38.20% of 3. Volume is much below that of wave three. This is a good place to buy a pull back if you understand the potential that is ahead for a Part 5. Still this 4 is often frustrating due to their lack of progress in the larger upward trend.

5: This is the final phase in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average traders finally buy in, right before the price tests/touches the top. Volume is often lower in 5 than in wave three, and many momentum trading indicators start to show divergences (the prices reach a new high but the indicators do not reach new highs). At the end of a major bullish market trend, bears may very well be ridiculed, for trying to pick a market top.

3 Pattern (Corrective Trend)

Three Wave Elliott Count Rules - Corrective Trend - 5 and 3 Wave Elliot Wave Count Rules

A: Corrections are often harder to identify than the impulse moves. In A of a bearish market, the fundamental news data is generally still positive. Most analysts see the drop as a correction in a still active bull market. Some indicators that accompany A include increased volume, rising and implied volatility & probably a higher open interest in selling/shorting.

B: Prices reverse & move slightly/a little higher, which many interpret as a resumption of the now long gone bullish market trend. Those familiar with classical analysis might see the peak as a right shoulder of head and shoulders reversal trading pattern. The volume during B should be lower and lesser than in A. By this point, fundamentals are probably no longer improving, but they most probably have not yet turned negative.

C: Prices move impulsively lower. Volume picks up, and by the third leg of C, almost nearly everyone realizes that a bearish trend is firmly entrenched. C is typically at least as large as A & often extends to 1.618 Fibonacci expansion level beyond A lowest point.

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