About the Elliott Wave Theory & Stock Market Predictions
The Elliott Wave Theory is one of the most often utilized and respected predictive models for investing in speculative markets like stocks and currencies. Ralph Nelson Elliott developed his theory through 75-plus years of research. He studied historical charts to develop models of repetitive waves in investments derived from the psychology of mass market investors.
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Basics
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Elliott published his findings at the age of 66 in his book "The Wave Principle." His intent was to help investors follow price structures in charts based on the well-known Fibonnacci sequence. He believed investment trends are built on impulse waves and corrective ways that play out through five impulse waves and three corrective waves in the direction of the trend (up or down), according to Acro Tec.
Wave Function
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Investment chart formation builds over time through impulse waves labeled one, three and five and corrective waves labeled two and four, according to the Stock Charts website. Elliott's theory is built on the premise that every larger wave has corresponding smaller, sub-waves that contribute. In essence, numerous small-to-large waves develop over time in an investment chart. Numeric and alphabetical labels are placed on visual depictions of charts by investors attempting to predict upcoming price action.
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Wave Names
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Elliott identified nine wave types and labeled them: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, and Sub-Minuette, according to the Stock Charts website. Grand Supercycle waves are considered the "major waves" or long-term waves in charts. Investors sometimes opt to trade on short-term waves, or price moves, but awareness of the long-term direction (up or down) of an investment is important regardless of investment strategy or time frame.
Wave Rules
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Elliott's theory includes identification of basic "wave rules," which are generally not to be broken when attempting to predict price action in an investment. Acro Tec notes key rules as being that Wave 2 (corrective) should not move below the starting point of Wave 1; Wave 3 should never be the shortest wave in a 1,3,5 impulse pattern; Wave 4 should not overlap with Wave 1 with rare exception; and the so-called "Rule of Alternation" indicates that Wave 2 and Wave 4 should develop in two unique wave forms. Investment analysts often view violations of these rules as confirmation of a faulty wave analysis.
Wave Patterns
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Identification of wave formations is often considered the most challenging aspect of correct market predictions using Elliott Wave Theory. Elliott developed three common impulse wave forms and six common corrective wave forms, according to Acro Tec. Misinterpretations of wave formations can contribute to faulty stock market predictions derived from wave analysis.
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References
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