Introduction to Elliott Wave Theory
Elliott Wave Theory is a form of technical analysis based on the idea that financial markets move in repetitive cycles driven by crowd psychology. Developed by Ralph Nelson Elliott in the 1930s, this theory highlights that price movements follow a natural rhythm of optimism and pessimism.
Elliott discovered that prices unfold in specific patterns called “waves,” and these patterns recur due to the collective behavior of market participants.
What Are Elliott Waves?
According to Elliott, markets move in two phases:
- Impulse Waves (5-wave pattern): Move in the direction of the trend.
- Corrective Waves (3-wave pattern): Move against the trend.
Impulse waves include 5 distinct waves (1, 2, 3, 4, 5), where Waves 1, 3, and 5 go with the trend, and Waves 2 and 4 are corrective pullbacks.
Corrective waves include 3 waves labeled A, B, and C.
Impulse Wave Breakdown
- Wave 1: Marks the beginning of a new trend.
- Wave 2: Pullback, but doesn’t retrace the entire Wave 1.
- Wave 3: The strongest and longest wave.
- Wave 4: A mild correction.
- Wave 5: Final push before a larger reversal.
Corrective Waves (ABC)
Corrective waves appear after a 5-wave trend and can take various forms:
- Zig-Zag: Sharp counter-trend moves.
- Flat: Sideways corrections.
- Triangle: Consolidation phases, can be symmetrical, ascending, or descending.
Fractals in Elliott Waves
Each Elliott wave is fractal in nature, meaning it can be broken down into smaller wave patterns. These fractals span various timeframes, from decades (Grand Supercycle) to minutes (Sub-Minuette).
Trading Forex with Elliott Waves
- Wave Counting: Identify waves on your chart to determine entry and exit points.
- Fibonacci Tools: Use retracement and extension levels to confirm waves.
- Stop-Loss Placement: Set below the start of Wave 1 if entering at Wave 2.
Example:
- Identify Wave 1 and Wave 2
- Confirm Wave 2 respects Fibonacci support
- Enter trade targeting Wave 3
Introduction to Harmonic Price Patterns
Harmonic patterns help traders identify precise turning points based on Fibonacci ratios. These setups must meet strict criteria, reducing subjectivity in technical analysis.
Key Harmonic Patterns:
- ABCD Pattern
- Three-Drive Pattern
- Gartley Pattern
- Crab Pattern
- Bat Pattern
- Butterfly Pattern
Gartley Pattern
Originated by H.M. Gartley, this pattern identifies key reversal zones using Fibonacci retracements and extensions.
- AB = 61.8% retracement of XA
- BC = 38.2% or 88.6% of AB
- CD = 78.6% of XA
Advanced Patterns
Crab Pattern:
- CD leg is a 161.8% extension of XA
- Offers a high risk-reward setup
Bat Pattern:
- CD leg retraces 88.6% of XA
- Reliable with tight stop-losses
Butterfly Pattern:
- CD leg extends 127% or 161.8% of XA
- Signals strong reversal opportunities
Final Thoughts
Both Elliott Wave Theory and Harmonic Patterns are powerful tools in a trader’s arsenal. While they require practice and precision, mastering these patterns can greatly enhance trading accuracy and confidence in the forex market.
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