How to master wave analysis - an algorithm for beginners
The principles of wave analysis in Forex are based on the cyclicity that is characteristic of any phenomenon in the world, whether it is a change of seasons or the rotation of planets around the sun. The movement of prices in the foreign exchange market is also subject to certain patterns. From the point of view of Ralph Elliott, price changes are wave-like. For beginners, his theory looks quite complicated. We will understand what a wave analysis is, how waves look and how to use it in trade.
How the waves look on the price chart
It includes two market conditions.
First, a bull trend develops. It consists of five waves. On the graph they are marked with numbers from 1 to 5. The first, third and fifth waves are called pulsed. Their direction corresponds to the main trend. The second and fourth are correctional waves.
The “bear” part of the wave consists of three waves. They are denoted by the Latin letters a, b and c. Here, pulsed waves are downward. There is only one correction wave (wave b).
The given model is characteristic for the “bull” trend. If you reflect the image in the figure above horizontally, you get a wave in a downward market.
If you see a similar figure on the chart of a currency pair, do not rush to enter the market. The Elliott Wave Theory has several parameters by which it is necessary to evaluate the waves. These include their length (duration in time), the shape and location of subsequent extremes relative to the previous ones.
Elliott Wave Formation Rules
Not every price movement that resembles the graphic model that you see in the image above can be called a wave. We will deal with the rules by which waves are identified in the Elliott theory.
The most important ones are listed here:
any impulse wave is always shorter than the correctional one;
the third impulse wave is usually larger than the first (it is considered the longest of all);
the second correctional wave is usually equal to half the first pulse;
the longest wave is usually 1.618 times larger than the usual (Fibonacci ratio);
The size of the waves in the theory of wave analysis also matters. Each subsequent wave is associated with the previous one in accordance with a sequence of Fibonacci numbers. In short, the correction for strong trend movement is usually 38%, and for weak - 62%.
Elliott Wave Theory Deficiencies
Wave theory, like any other Forex technical analysis tool, is not without flaws. Essential only two.
The subjective nature of the assessment of the market situation.
The main postulates of the theory of wave analysis are described above, but there are much more rules for determining waves and trading them. If you show the same chart to two different traders “wave guides”, with a high degree of probability they will see a different picture on it and draw different waves. Accordingly, the trading tactics will also differ significantly. However, it can be successful even in such a situation. Technical indicators that accurately and correctly detect waves on the chart have not yet been invented.
Good on history, hard on practice.
Wave models are easily identified on historical data. Visually, it is easy to distinguish between impulse waves and corrective ones, to suggest where to enter the market correctly. In the real market, things are different. In the trading mode here and now it is difficult to understand where one wave begins, where the second ends.
Also one of the disadvantages of wave analysis is the complexity of the perception of information. Each wave in the model also consists of several subwaves. It is difficult for a novice trader to understand a large amount of information, however, if desired, you can quickly master the wave analysis.