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Elliott Wave Theory Basics

R. N. Elliott developed his wave theory in 1934. It is a method for explaining stock market movements.

Elliott Wave Technical Analysis rules and guidelines applied to the charts, and will help you trade and invest successfully through a better understanding of the market to maximize opportunity and minimize risk.

Under the Elliott Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and, by communicating transactional data to investors, joins the chain of causes of others' behavior.

According to the Elliott Wave Theory, stock prices tend to move in a predetermined number of waves. Elliott believed the market moved in five distinct waves on the upside (Motive or Impulse Wave) and three distinct on the downside (Corrective Wave).

Motive wave structure is denoted by numbers (1-2-3-4-5) and, corrective wave structure is denoted by letters (a-b-c). 

Market cycles are composed of Motive Wave and Corrective Wave, So one complete cycle consists of eight waves.

Elliott Wave Theory Figure 1
Figure 1

Elliott Wave counting and degrees

An important feature of Elliott Wave Theory is that they are fractal in nature. 'Fractal' means market structure is built from similar patterns on larger or smaller scales. Therefore, we can count the wave on a long-term yearly market chart as well as short-term hourly market chart.

Elliott Wave Theory Figure 2
Figure 2

Elliot Wave theory categorizes waves by relative size, or degree. Elliott discerned nine degrees of waves, and chose the names listed below to label these degrees, from largest to smallest:

  1. Grand Supercycle
  2. Supercycle
  3. Cycle
  4. Primary
  5. Intermediate
  6. Minor
  7. Minute
  8. Minuette
  9. Sub-Minuette

The major waves determine the major trend of the market, and minor waves determine minor trends.

Rules for Wave Count

Based on the market pattern, we can identify ' where we are' in term of wave count. Nevertheless, as the market pattern is relatively simplistic, there are several rules for valid counts: 

  1. Wave 2 should not break below the beginning of Wave 1; 
  2. Wave 3 should not be the shortest wave among Wave 1, 3 and 5; 
  3. Wave 4 should not overlap with Wave 1, except for wave 1, 5, a or c of a higher degree. 
  4. Rule of Alternation : Wave 2 and 4 should unfold in two different wave forms. 

Learn More

Elliott Wave International's tutorial is the most comprehensive introduction to the Elliott Wave Principle available in cyberspace. All ten lessons have been adapted from Prechter and Frost's Wall Street bestseller, Elliott Wave Principle - Key to Market Behavior .

To start your Elliott wave education now, click here.

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