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Elliott
Wave Theory in Forex Markets
One of the best known and least understood
theories of technical analysis in forex trading is the Elliot
Wave Theory. Developed in the 1920s by Ralph Nelson Elliot
as a method of predicting trends in the stock market, the Elliot
Wave theory applies fractal mathematics to movements in the
market to make predictions based on crowd behavior. In its
essence, the Elliot Wave theory states that the market
– in this case, the forex market – moves in a series of 5 swings
upward and 3 swings back down, repeated perpetually. But if
it were that simple, everyone would be making a killing by
catching the wave and riding it until just before it crashes
on the shore. Obviously, there’s a lot more to it.
One of the things that makes riding the Elliot Wave so tricky
is timing – of all the major wave theories, it’s the only one
that doesn’t put a time limit on the reactions and rebounds
of the market. A single In fact, the theories of fractal mathematics
makes it clear that there are multiple waves within waves within
waves. Interpreting the data and finding the right curves and
crests is a tricky process, which gives rise to the contention
that you can put 20 experts on the Elliot Wave theory in one
room and they will never reach an agreement on which way a
stock – or in this case, a currency – is headed.
Elliot Wave Basics
Every
action is followed by a reaction.
It’s a standard rule of physics that applies to the crowd
behavior on which the Elliot Wave theory is based. If prices
drop, people will buy. When people buy, the demand increases
and supply decreases driving prices back up. Nearly every system
that uses trend analysis to predict the movements of the currency
market is based on determining when those actions will cause
reactions that make a trade profitable.
There
are five waves in the direction of the main trend followed
by three corrective waves (a "5-3" move).
The Elliot Wave theory is that market activity can be predicted
as a series of five waves that move in one direction (the trend)
followed by three ‘corrective’ waves that move the market back
toward its starting point.
A
5-3 move completes a cycle.
And here’s where the theory begins to get truly complex.
Like the mirror reflecting a mirror that reflects a mirror
that reflects a mirror, the each 5-3 wave is not only complete
in itself, it is a superset of a smaller series of waves, and
a subset of a larger set of 5-3 waves – the next principle.
This
5-3 move then becomes two subdivisions of the next higher
5-3 wave.
In Elliot Wave notation, the 5 waves that fit the trend are
labeled 1, 2, 3, 4 and 5 (impulses). The three correcting waves
are called a, b and c (corrections). Each of these waves is
made up of a 5-3 series of waves, and each of those is made
up of a 5-3 series of waves. The 5-3 cycle that you’re studying
is an impulse and correction in the next ascending 5-3 series.
The
underlying 5-3 pattern remains constant, though the time
span of each may vary.
A 5-3 wave may take decades to complete – or it may be over
in minutes. Traders who are successful in using the Elliot
Wavy theory to trade in the currency market say that the trick
is timing trades to coincide with the beginning and end of
impulse 3 to minimize your risk and maximize your profit.
Because the timing of each sequence of waves varies so much,
using the Elliot Wave theory is very much a matter of interpretation.
Identifying the best time to enter and leave a trade is dependent
on being able to see and follow the pattern of larger and smaller
waves, and to know when to trade and when to get out based
on the patterns you identify.
The key is in interpreting the pattern correctly – in finding
the right starting point. Once you learn to see the wave patterns
and identify them correctly, say those who are experts, you’ll
see how they apply in every facet of forex trading, and will
be able to use those patterns to trigger your decisions whether
you’re day trading or in it for the long haul.
# # # # # SolveYourProblem.com : 2007
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