Elliott Waves: A Powerful Tool For Technical Analysis (Part 1)
Technical analysis is a way to predict future price movement by examining the chart of the token, stock, etc… that you want to predict. To do this, there are multiple indicators that can help, such as the RSI or the MACD.
You can also use chartist patterns, which involve identifying patterns that repeat themselves, much like Elliott Wave Theory based on cycle identification.
Little Bit Of History
Ralph Nelson Elliott (1870–1948) initially developed Elliott Wave Theory in the 1930s before its widespread adoption among traders and market analysts through the work and publications of Robert Prechter starting from 1970.
How Does It Work ?
According to Elliott Wave Theory, every market evolves according to a trend sculpted by a series of waves. The waves unfold in a recurring pattern driven by the evolving dominant sentiment of investors.
So, according to Elliott, every uptrend market follows a cycle of 5 waves. In an uptrend, there are 3 impulsive waves (1, 3, 5) that push the price higher and 2 corrective waves of retracement (2 and 4).
It’s important to remember that Elliott Wave Theory is related to the psychology of investors, so each wave has a meaning behind it :
-The first wave of an uptrend movement is due to the first buyers initiating an entry in anticipation of a bull market (usually whales and large investors).
-The second wave is a correction of the first one and allows early investors to accumulate even more.
-The third wave is the most powerful one; it’s never the shortest. It’s when everyone knows that we are in the bull market, so the consensus is very bullish.
-The fourth wave is a retracement of the third wave. It’s usually a profit-taking phase for early investors.
-The fifth and last wave is an euphoric phase where mainstream media start talking about it and signs of weakness of the momentum appear (bearish divergence on the RSI, for example).
So, it’s important to note that the first wave (the hardest to find) always starts from a strong support level.
The great thing is that you can know how far each wave can technically go with the Fibonacci retracement tool :
The Second wave usually retraces 0.382, 0.5, or 0.618 of the first wave.
The Third wave is 1.618 or 2.618 times the length of the first wave.
The Fourth wave is a correction of 0.382 or 0.5 of the first wave.
The Fifth Wave is usually the length of wave 1 or 1.618 times the length of the first wave.
Keep in mind that those Fibonacci numbers might not be exact, but they are the most recurring.
Here are how to find the tools I used on TradingView :
Moreover, there are some important rules to know :
- Corrective waves don’t go lower than the top of the last wave (Wave 4 doesn’t go lower than the top of Wave 1).
- The Third wave is the most impulsive wave.
It’s important to remember that Elliott Wave Theory is not always right and might mislead traders if they falsely count waves. So always use other indicators to back your vision of the market.
I’ll cover the Elliott wave theory for when we are in a bearish trend in another article. Because yes, you can predict the bottom of trends with Elliott.
As always thank you for reading !
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Disclaimer : This is not a financial advice, you need to do your own research !
