Elliott Wave theory, developed by Ralph Nelson Elliott, states that market prices develop in trends. Using Dow theory and natural observations, Elliott concluded that movement of the stock market can be forecasted through observations and identifying repeated patterns called waves. Elliott was able to find the fractal nature of market while working on Dow theory. He published his work in a book titled The Wave Principle in 1938 where he analyzed in greater depths.
Elliott Wave analysis has probably its biggest advantage as a forecasting tool on short- to medium-term time frames. However, it also has shortcomings in practice. Nevertheless, the method provides a framework to describe the maturity of a trend in sufficient detail. It enables the definition of each and every portion of a trend.
Basic Principle of Elliott Wave Theory:
The Elliott Wave Principle puts forward that collective investor psychology, or crowd psychology, moves between positivity and negativity in natural succession. These mood swings create patterns evidenced in the price movements of markets at every degree of trend or time scale. Trends alternate between an action (motive) phase and a corrective phase. Motive phases are dominating the trend. Price action unfolds in their direction.
There are two main types of waves:
Motive waves create progress and form a trend. The price movement is actionary within motive waves as opposed to reactionary within corrective waves. Such waves are easier to recognize than corrective waves. We distinguish between two main categories:
2. Corrective Waves
Corrective waves cause reactions against a trend. The price movement is reactionary within corrective waves. We distinguish between four main correction categories. The primary challenge for corrective waves arises from combinations. Combination possibility increases the number of possible correction patterns to more than 20.
This applies on all time scales. Smaller time frames are called fractals. Fractals are mathematical structures, which on a smaller scale infinitely repeat themselves. Our wave notations are as follows:
Grand Supercycle I°/a°
Primary 1°or ① / A° or Ⓐ
Minute i° or ⓘ / a° or ⓐ