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What is Elliot Wave Theory?


Elliot wave: The theory is developed by Ralph Nelson Elliot in 1930. It is a technical tool used by traders to analyse the market trend, investor’s psychology and stock prices. Elliot observes the market deeply and understands the movement of the stock prices by repetitive patterns of market trends. His theory is based on Dow Theory.
This theory consist 8 waves which shows bullish and bearish both market trend. It works on 5:3 patterns which mean 5 waves up and 3 waves down. Impulsive wave show a trend in the main direction. In Elliot wave 1, 3, and 5 are impulsive wave and 2, 4 are corrective waves. Corrective waves are those which retrace the upward movement of wave. The total five waves show the bullish market trend and 3 waves show bearish market trend.
A diagram which shows Elliot wave is given below:
·         In the above diagram the 1st wave starts from base and then move upward to show rising trend of market. This wave is impulsive wave and it moves in one direction and then market show decline in stock prices or market decline trend.
·         Then decline wave is corrective wave and it form 2nd wave in Elliot wave. After showing declining phase the market again start rising in upward direction but at this time market show high growth in market trend or stock prices. At this point 3rd wave is formed.
·         The 4th wave will move in opposite direction to show the decline of stock prices or market trends.  
·         Then impulsive wave has formed to show the positive growth in market trends. This wave is known as 5th wave.
·          After 5th wave there will be a correction in the market trend by 3 waves named as A, B and C. The correction of the market trend has started by declining of stock prices or trend then after some time the market shows positive result by raising the trend through “B”. But after some point of time it shows negative results in the form of wave “C”.
·         In above diagram the 8 waves shows the major trends. To show the minor changes in trend these 8 waves subdivided into 2 parts impulsive wave and corrective wave. And each impulsive wave subdivided into 5 waves as (i), (ii), (iii), (iv) and (v) to form 1 impulsive wave.  And each corrective wave is subdivided into a, b and c.

Rules to check the Elliot wave is formed or not?
·         The 3rd wave is rises higher then 1st wave or you can say the 3rd wave move upward higher then 1st wave.
·         The 2nd wave does not decline or retrace more than 100% of wave 1. It means wave 2nd does not go below the starting point of wave 1.
·         The 3rd wave must be higher than 3 impulsive waves. It means 3rd wave must be longest wave then wave 1st and wave 4th.
·         The 4th wave does not go below then wave 1 peak point. The 4th wave must be above the 1st wave top level point to form an Elliot 4th wave.


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