Elliott wave theory provides the basis for wave analysis. Wave analysis argues that fluctuations of rates and prices in financial markets are caused by changes in social mood, for example from optimism to depression and vice versa in accordance with natural phenomenon. These changes follow set patterns which recur over time and can be used to predict the future trend. The theory was discovered in the 1930s by an accountant called Ralph Nelson Elliott. In 1946 he published his book “Nature’s Laws – The Secret of the Universe”.
A crowd is always a crowd, whether it is a crowd of soccer fans or a crowd of Forex traders. In fact the theory postulates that the development of any system with economic and social participation of human beings will inevitably repeat in time and scale (fractal) cycles of the same wave drawings (patterns).
The original extract from the book devoted to market prices is as follows: “…market prices alternate between five waves at all degrees within a trend, as the illustration shows. As these waves develop, the larger price patterns unfold in a self-similar fractal geometry. Within the dominant trend, waves 1, 3 and 5 are “motive” waves, and each motive wave itself subdivides in five waves. Waves 2 and 4 are “corrective” waves, and subdivide in three waves. In a bear market the dominant trend is downward, so the pattern is reversed – five waves down and three up. Motive waves always move with the trend, while corrective waves move opposite it”.
Waves consisting of three smaller waves are called triples. Waves consisting of five waves are called fives. Both of them consist of smaller semi-similar waves of a smaller scale and different levels of these structures (fractals) are called degrees. Pay attention to the lower, which are the most detailed variant of the example of Elliott waves above. In a small sequence there are five: waves 1, 3 and 5 are motive and waves 2 and 4 are corrective. This means that the move of a wave of a greater scale (second from below) in this section is rising. Also, it tells us about the first minor corrective sequence (sequence of triples). After the first series of rising fives and corrective down threes, the sequence starts over, in general as if repeating the trajectory of itself but one degree higher. The full motive pattern for the lower diagram consists of 89 waves, and the full corrective cycle consists of 55 waves.
Every degree of a pattern has its own name in the financial markets. These degrees depend on the chosen time scale, but in general the majority of wave analysis adherents agree to the following classification:
- Grand supercycle is in the scale of centuries
- Supercycle is the scale of decades (usually 40-70 years)
- Cycle is a period from one year to a couple of years, sometimes in decades (but less than 50)
- Primary is a period from a couple of months to two years
- Intermediate – from weeks to months
- Minor – a period of weeks
- Minute is in the scale of days
- Minuette accounts for hours
- Subminuette represents periods of minutes
In essence, wave analysis – an approach based on Elliott wave theory – is reduced to the goal of recognizing images. It is during the identification of wave