The Elliot Wave Principle in general is a description on behavior of groups of people behave and reveals that mass psychology swings from being cynical to optimistic, are forming specific and determinable patterns.
Ralph Nelson Elliot discovered Elliot Wave Theory in the 1930s. He was a corporate accountant by profession; studied price movements and found out that there are certain patterns which repeat themselves. He could accurately forecast the stock market through his principle. He likewise identified the common link driving the trends psychological reaction of the masses: from financial markets to fashion, from politics to popular culture, and so on.
Describing Elliot Wave Patterns
You are able to know the up and down, showing that the swings of psychological behaviors appeared the same repetitive patterns. He classified his terms as waves & into two categories: The Impulsive Wave & the Corrective Wave.
The impulse waves moves towards the direction of the dominant trend in the market. They can be sub-divided into 5-wave structure labeled as 1, 2,3,4,5. It is called impulsive wave as it plays an important role in the market movement.
Corrective waves, on the other hand, identify the count trend moves. This three-wave pattern labeled as a, b, c, is a corrective response following an impulsive wave.
As market structure is located on similar patterns on a bigger or a smaller scale, the wave can be counted on a yearly market chart on a long-term basis, as well as an hourly market chart on a short-term basis.
The Five Movements
The Elliot Wave Theory is appropriate for foreign exchange market as well as for stock market, currencies, bonds and much more. The following is a brief description of what was recorded during each wave in a stock market transaction.
Wave 1: Stocks start to move upwards. It was felt by the investors that the stock prices are good and that it was the perfect timing to invest leading to cause the price gain momentum.
Wave 2: Some people in the original bunch considered that the stocks are overpriced and take profits. It causes the market drop. The stock, though, won’t be able to reach the previous level before it is reconsidered as bargain.
Wave 3: It is the longest and most impulsive wave. The stock has captured the attention of the investing public and wanted a share of the stock. Here, demand is directly proportional to its price.
Wave 4: It is the point wherein investors believe the value of stocks is extreme and take in profits. This wave usually breaks down as more people are still feverish on the stock and are holding on to “buy on the dips”.
Wave 5: This wave drives people on the edge of hysteria to purchase stock despite of reasons. This is the point where in the stock really got overpriced and will move into one of the two patterns, either towards a correction (pattern a, b, c) or will start from wave 1 again.