What Is The Elliott Wave Theory?
Many traders may have heard about the Elliott Wave Theory.
But only a handful truly understands the forecasting capabilities it encapsulates as a trading methodology.
Irregardless of whether you’re a newbie or have years of experience.
Every trader understands and acknowledges one simple concept when it comes to trading.
A time tested trading system is essential when it comes to making consistent profits from the financial markets.
And the Elliott Wave Theory might just be that system if one is able to fully comprehend and utilize its forecasting capabilities.
Is The Elliott Wave Theory Still Relevant?
There are a lot of different trading methodologies out there that claim to be the “Holy Grail” of trading.
Many boasting opportunities for making big trades and even bigger returns.
But how valid and how consistent are their trading results are truly questionable.
However, there is one trading methodology that has been around for decades.
One that has withstood the test of time despite modern technology advancements.
This methodology is still widely used today by both novice and advanced traders alike.
Even top hedge fund managers like Paul Tudor Jones attributed their success to it.
And no prizes for guessing what it is.
Foundations Of The Elliott Wave Principle
The Elliott Wave Theory is an analytical methodology used by savvy traders looking to study the market cycles of the financial market.
In essence, it is a market forecasting tool.
One that is used to predict market trends by identifying extreme turning points on the charts.
Its core principle is based on analyzing the collective psychology of the mass market participants.
Ralph Nelson Elliott
R.N Elliott is the genius mastermind behind the Elliott Wave Principle which was developed in the late 1930's.
Elliott worked as a dedicated accountant for the majority of his career prior to furthering his studies into this unique forecasting tool.
From his research, Elliott deeply studied the core behavior of human nature.
He observed that this behavior could be quantified and predicted long ahead of any specific situations or events actually happening.
Using the principles of his Elliott Wave Theory, he set out to prove that human psychological activity could be predicted and projected systematically and repeatedly using this system.
The Wave Principle
In his book titled “The Wave Principle”, Elliott proposed that although the stock market may appear random and unpredictable.
But they actually follow predictable, natural laws and can be measured and forecast.
And the nature of these price fluctuations typically follows a sequence of Fibonacci numbers.
Soon after the publication of his book, the Financial World magazine commissioned Elliott to write twelve articles describing this new method of market forecasting.
During a time when the internet and computers were not even invented, the Elliott Wave Theory was one of the pioneer price action methodologies.
One in which binary points of data could be estimated and predicted efficiently.
Dominance Of High Frequency Trading
Nowadays, with modern technological advancements, financial markets often "Automated" in nature.
Financial activities are essentially running on the backs of super computers and artificial intelligence.
There are reports stating that the majority of the daily moves in financial markets are dictated purely by computer algorithms alone.
These types of High Frequency Trading are dominant and running rampant especially during the Intra-day trading time frames.
However, a point to note is that retail traders still make up a significant portion of all the trading activity that occurs every day in the global financial markets.
And when the emotional tsunami of greed and fears grips the markets, reckon nothing can still stand in its path.
Reflection Of Human Emotions
The foundations of the Elliott Wave Theory is built primarily on analyzing mass human psychology.
It analyses human behavioral patterns and environmental stimulus variables to forecast price movements.
And the emotional fallacies of greed and fear have been found to have a direct correlation on how retail traders react to surrounding news concerning the financial markets.
Having said that, we are fully aware that the financial markets can be highly "Irrational" at times.
Just take a look at the US Indices during the 2020 COVID pandemic.
The world is in chaos, global economies are closed.
Yet the stock markets kept rising due to the liquidity rush fueled by the FED.
And the Elliott Wave charts never lie.
It just explicitly reflects the underlying greed of the mass market participants.
Limitations Of The Elliott Wave Theory
One of the core issues when applying the Elliott Wave Principle is the "Real Time" application.
Many aspiring traders find the methodology to be too "Vague" and "Loose-Ended" to identify and verify in real time.
And I can bet my bottom dollar that every Elliott Wave trader has certainly experienced this feeling of "Loss" and "Uncertainty" at some point in their learning journey.
To the untrained eye, the mechanics by which a novice trader attempting to use the Elliott Wave Principle to identify when a “Wave” starts and ends, is “Technically” not verifiable until the move has ended.
But with more “Screen-Time”, practicing the Elliott Wave Theory brings about an enhanced understanding of price action.
This is often achieved through repeated pattern recognition only experienced traders can relate to.
While some traders might continue to debate about the real time application of the Elliot Wave Principle.
What I observed is that the core principles surrounding the Elliott Wave Principle is still sound and valid in my opinion.
Albeit more evident and easier to recognize and identify in the longer term perspective such as the Weekly or Monthly time frames.
Evolution Of The Elliott Wave Theory
However, with continual advancement and evolution in the trading environment brought forth by technology.
The modern day adaption of the Elliott Wave Theory tends to gravitate towards Harmonic Elliott Waves.
It essentially states that the odds of predicting market values accurately is substantially increased when you look for “Harmony” within the wave structures you’re studying.
In short, instead of the standard 5 waves up and 3 waves down, we are typically looking at correlated 3 wave moves all around.
The validity of this new “modernized” approach to the Elliott Wave Theory is still under strict scrutiny.
And that is why this trading method is not commonly widespread and readily acceptable by most Elliott Wave technicians.
For any experienced Elliott Wave practitioner, there is little debate that the legacy Elliott Wave Theory is still largely applicable.
This is despite the vast technological advancements we have witnessed in the modern day trading environment.
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For more articles on the Elliott Wave Principle, check out our other posts in our Elliott Wave Blog.