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Elliott Wave Theory And Its Application In Boston Forex Trading – The Elliott Wave Theory is a technique of technical analysis that attempts to predict trends and cycles in the financial market by identifying recurring patterns in market price movements.
The theory is based on the idea that market prices move in waves, and that these waves can be classified as impulse waves (trending waves) or corrective waves (trending waves).
Elliott Wave Theory And Its Application In Boston Forex Trading
Ralph Nelson Elliott, an American accountant and stock market analyst, developed the theory in the 1930s. He observed that market prices tend to be predictable, and that these patterns are influenced by human psychology and emotions.
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According to the Elliott Wave Theory, market prices move in a five-wave pattern in the directional direction, followed by a three-wave correction pattern against the direction. A five-wave pattern is known as an impulse wave, while a three-wave pattern is called a corrective wave.
Elliott Wave analysts use chart patterns and technical indicators to identify these patterns and determine the direction of future price movements.
While the Elliott Wave theory has its supporters, it is also criticized by traders and other analysts for its subjective nature and possible interpretation bias.
Elliott Wave theory is built on several basic concepts and terms that traders and investors should be familiar with. These concepts include interest waves, tuning waves, and degree waves.
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Interest waves are the main trend waves in Elliott Wave Theory, consisting of five waves that move in the direction of the underlying trend. There are two types of impulse waves, impulse waves and diagonal waves.
Impulsive waves are the most common type of impulse wave in Elliott Wave Theory. They are made up of five waves, three of which are the main upward (or downward) direction, while the other two are corrective waves in the opposite direction.
In the upper case, the impulse wave consists of three high waves (1, 3, 5) and two low waves (2 and 4). Conversely, in a downtrend, the impulse wave consists of three low waves (1, 3, 5) and two high waves (2 and 4).
Horizontal waves are less common than impulse waves and consist of five waves that move in a diagonal pattern. There are two types of diagonal waves, ie leading diagonal and ending diagonal.
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The leading diagonal moves towards the base direction, while the trailing diagonal moves against the base direction.
A corrective wave is a counter wave that occurs after a wave of interest has completed. They consist of three waves that move against the fundamental direction. There are three types of corrective waves, zigzag, flat, and triangle.
Zigzags are a common type of corrective wave, and consist of three waves. In the uptrend, the first wave (A) is a down wave, followed by an up wave (B), and finally, another down wave (C).
In a downtrend, the first wave (A) is the high wave, followed by the low wave (B), and then the high wave (C).
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Flats are corrective waves that move in a sideways pattern. They consist of three waves, with the second wave retracing at least 80% of the first wave. In an uptrend, the first wave (A) is a high wave, followed by a sideways wave (B), and finally another high wave (C).
Conversely, in a downtrend, the first wave (A) is a downward wave, followed by a sideways wave (B), and then another downward wave (C).
A triangle is a corrective wave that moves in a triangle pattern. They consist of five waves that move in a converging pattern.
In the upper case, the triangle is formed by the lower and lower series, while in the lower case, the triangle is formed by the lower and lower series.
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Wave degrees are used to classify the magnitude of trend waves in Elliott Wave Theory. There are nine degrees of waves, from the smallest to the biggest superbikes. The nine degrees of waves are:
To use the Elliott Wave Theory effectively, traders and investors must follow certain rules and guidelines. These rules are designed to help identify and confirm signal patterns, as well as anticipate future price movements.
Wave counting is an important part of Elliott Wave Theory. In order to correctly identify signal patterns, traders must follow specific rules for calculating signals. Some of the most important rules for calculating tides include:
The commutative rule indicates that the modulating signals in the structure should be interchanged in their form and complexity. For example, if the first corrective wave is a zigzag, the second corrective wave should be flat or triangular.
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The principle of equality suggests that the second impulse wave in a pattern should be equal in height to the first impulse wave. This rule applies to interest signals but not to modulation signals.
The rule of proportion suggests that the waves in a structure should be related to each other in a specific ratio. For example, if wave 1 is 100 points, wave 3 should be 161.8% of wave 1, and wave 5 should be 61.8% of wave 3.
Fibonacci relationships are an important part of Elliott Wave Theory. The Fibonacci ratio is a mathematical ratio derived from the Fibonacci sequence (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.).
These ratios are used to identify potential support and resistance levels and to project future price targets. The three most commonly used Fibonacci levels in Elliott Wave Theory are:
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Reversal levels are used to identify potential support or resistance levels during a corrective wave. Typical retracement rates are 38.2%, 50%, and 61.8% of the previous wave.
For example, if wave 1 is 100 points, the possible retracement levels for wave 2 would be 38.2 points, 50 points and 61.8 points.
Expansion levels are used to prepare wave price targets. The most commonly used extension levels are 161.8%, 261.8%, and 423.6% of the original wave.
For example, if wave 1 is 100 points, the possible expansion levels of wave 3 will be 161.8 points, 261.8 points and 423.6 points.
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Fibonacci area watches are used to identify potential wave target timeframes. These zone clocks are based on the Fibonacci sequence and are used to identify potential turning points in the market.
The most commonly used Fibonacci time periods are 38.2%, 50%, and 61.8% of the time taken for the previous wave to complete.
The Elliott Wave Theory is an important tool for traders and investors who want to analyze financial markets and make sound trading decisions. In this section, we will discuss some practical applications of Elliott Wave Theory.
One of the most important applications of the Elliott Wave Theory is to identify market trends. By analyzing signal patterns, traders can determine if the market is in an uptrend, downtrend, or consolidation.
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Another important application of the Elliott Wave Theory is to predict market movements. By recognizing the completion of a wave pattern, traders can anticipate possible changes in the market. This information can be used to enter or exit trades and manage risk.
Elliott Wave theory can also be used to develop risk management and trading strategies. Some common strategies include:
Traders can use signal patterns to identify potential entry and exit points. For example, a trader may enter a long position at the beginning of an impulse wave and exit the trade at the end of the wave.
Traders can use signal patterns to determine appropriate stop loss levels. For example, a trader can place a stop loss below the beginning of an impulse wave to minimize potential losses.
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Traders can use signal patterns to determine the size of positions suitable for trading. For example, a trader can increase their position size during an impulse wave and decrease their position size during a corrective wave.
Finally, Elliott Wave Theory can be combined with other technical analysis tools to improve the accuracy of trading decisions. Some common tools include:
Although the Elliott Wave Theory is a useful tool for analyzing financial markets and making sound trading decisions, it is not without limitations and criticisms. In this section, we will discuss some of the major limitations and criticisms of Elliott Wave Theory.
One of the main criticisms of Elliott Wave Theory is the subjectivity involved in calculating waves. Wave patterns can be open to interpretation, and different analysts may recognize different wave counts.
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Another limitation of Elliott Wave Theory is hindsight bias. This occurs when analysts apply theory to historical price data and adjust wave calculations to fit the data after the fact. This can lead to excessive skewing of the data and can make the theory unreliable for future price predictions.
The Elliott Wave theory is based only on the analysis of price data and does not take into account external factors that can affect market trends, such as political events, economic data releases or unexpected news.
Elliott Wave theory relies heavily on historical data to identify wave patterns and predict future price movements.
However, market conditions and trends can change over time, which can make historical data less relevant for predicting future price movements. This can reduce the effectiveness of the theory in a volatile or rapidly changing market.
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