Elliott Waves Theory - Definition
Written by Jason Gordon
Updated at December 19th, 2020
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Elliott Wave Theory Definition
The Elliott Wave Theory was developed in 1933, it was developed as an approach to describing price movements in the market as well as prevalent market cycles. This theory was named after Ralph Nelson Elliott, the scholar who developed it. This theory studies, describes and analyzes market trends, price cycles or price movements in the market. According to this theory, price movements in financial market behave in a random pattern or wave pattern.
A Little More on What is the Elliott Wave Theory
The Elliott wave theory can be applied to trading, this theory provides a technical analysis for price movements using various market indexes. Ralph Nelson Elliott developed this theory after an in depth study of charts across diverse indexes. However, the theory gained a bad reputation in 1935 when a bizarre prediction of stock market bottom was made by Elliot. The Elliott wave theory contains rules on how wave patterns can be identified and analysed across various markets, it has since then become a standard used by investors traders and portfolio managers for monitoring price movements in the financial market. However, elliott noted that the price patterns identified in the market are not accurate gauge of future price movement, the patterns just give probabilistic suggestions about potential future trends. The patterns can also be used alongside other technical indicators to identify opportunities in the market and otherwise.
How Elliott Waves Work
Impulse waves and corrective waves are the core components of the Elliott waves theory. The impulse waves have five sub-waves while the corrective waves comprises of three sub-waves. Also, the impulse waves entails net movement in the direction of the next-largest degree while the corrective waves make net movement opposite the pattern of the next-largest degree. Using the Elliot wave theory, a chart can be studied to have a number of impulse waves while another will have corrective waves. The outlook of the chart is important in helping investors realize the tendency for a long-term bearish trend or a short-term bullish trend in the financial market. There are other technical indicators of price movement in the market that were developed by a number of analysts after R.N. Elliott developed the Elliott Wave theory. These technical indicators are also helpful in the analysis of price trends and patterns over a period of time. The Elliott Wave Oscillator is an indicator developed by other analysts, it drew insights from the Elliott Wave principle. The Elliott Wave Oscillator uses a computerised system to predict the direction of future price movements. Drawing insights from the rules and guidelines of the Elliott wave principle, the Elliott wave oscillator has been an effective technical indicator used to identify price movements in the market.