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Ride the Wave – The Elliott Wave Theory for Forex Markets

The Elliot Wave Theory of technical analysis in Forex trading is the one of the best known and at the same time the least understood theories. Created in the 1920s by Ralph Nelson Elliot as a way to forecast trends in the stock market, the Elliot Wave theory applies fractal mathematics to movements in the market in order to make predictions based on crowd behavior. The theory in its fundamental nature states that the market, in this case, the Forex market, moves in a series of 5 swings upward and 3 swings downwards, repeated continually.

however if it were that easy, one and all would be waiting to catch the wave and ride it until just before it crashes on the shore. Clearly, there’s a lot more to it. Among the things that make riding the Elliot Wave so tricky we find timing, of all the major wave theories, it’s the only one that doesn’t put a deadline on the reactions and recoils of the market. To illustrate, the theories of fractal mathematics makes it clear that there are several waves within waves.

Reading the info and locating the right curves and crests is a difficult process, which gives base to the debate that you can put 20 experts on the Elliot Wave theory in one room and they will in no way reach an agreement on which way a stock, or in this case, a currency, is going.

Elliot Wave Basics

* Every action is followed by a reaction.
It’s a typical rule of physics that applies to the crowd behavior and on which the Elliot Wave theory is based. If prices go down, people will buy. When people buy the demand augments so the supply declines taking the prices up again. About every system that uses trend analysis to foresee the movements of the currency market is based on determining at what moment those actions will provoke reactions that will make a trade lucrative.

* There are five waves in the direction of the main trend followed by three corrective waves (a "5-3" move).
The Elliot Wave theory says that the market activity can be foreseen as a series of five waves that move in one direction (the trend) followed by three ‘corrective’ waves that move the market back toward its starting point.

* A 5-3 move completes a cycle.
This is the point where the theory begins to get really intricate. Like the mirror reflecting a mirror that reflects a mirror that reflects a mirror, the each 5-3 wave is not only complete in itself; it is a superset of a smaller series of waves, and a subset of a larger set of 5-3 waves.

This 5-3 move then gets to be two subdivisions of the next higher 5-3 wave.
In Elliot Wave documents, the 5 waves that fit the trend are tagged 1, 2, 3, 4 and 5 (impulses). The three correcting waves are named a, b and c (corrections). Each of these waves is made up of a 5-3 series of waves, and each of those is made up of a 5-3 series of waves. The 5-3 cycle that you’re studying is an impulse and correction in the next ascending 5-3 series.

The underlying 5-3 pattern stays steady, though the period of time of each may vary.
A 5-3 wave may take decades to complete, or it may happen to be done in minutes. Traders who are doing good in using the Elliot Wavy theory to trade in the currency market state that the trick is to coincide the timing trades with the beginning and end of impulse 3 to reduce your risk and make the most of your profit.

Given that the timing of each sequence of waves varies so much, making use of the Elliot Wave theory become actually a matter of interpretation. Identifying the best time to enter and leave a trade is at the mercy of being able to see and follow the pattern of larger and smaller waves, and to discern the moment to trade and the moment to get out based on the patterns you spot.

The important thing here then is to interpret the pattern accurately, to find the right starting point. The experts say that as soon as you learn to see the wave patterns and identify them properly, you’ll see the way they apply in each aspect of the Forex trading and be capable to make use of those patterns to set off your decisions whether you are just an apprentice or a veteran inside Forex.