The Elliott Wave Theory Explained | CFA Level 1 - AnalystPrep (2024)

FAQs

The Elliott Wave Theory Explained | CFA Level 1 - AnalystPrep? ›

Basic Tenets of the Elliott Wave Theory

The Elliott Wave Theory is a form of technical analysis that looks for recurrent long-term price patterns related to persistent changes in investor sentiment and psychology. The theory identifies impulse waves that set up a pattern and corrective waves that oppose the larger trend.

Identifying Wave 1 in Elliott Wave theory involves keen observation and analysis. Look for the following key aspects: Strong Impulse Movement: Wave 1 typically exhibits a strong, impulsive price movement in the direction of the emerging trend. Watch for decisive and noteworthy price shifts.

The Elliott wave principle, or Elliott wave theory, is a form of technical analysis that financial traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology and price levels, such as highs and lows, by looking for patterns in prices.

Where the impulse wave had a general structure count of 5-3-5-3-5, the ending diagonal has a structure count of 3-3-3-3-3. All five of the waves of an ending diagonal break down to only three waves each, indicating exhaustion of the larger degree trend.

The theory

Elliott believed that every action is followed by a reaction. Thus, for every impulsive move, there will be a corrective one. The first five waves form the impulsive move, moving in the direction of the main trend. The subsequent three waves provide the corrective waves.

To trade Elliott waves, you first determine whether your market is in a bull or bear trend, and then whether it is in the motive or corrective phase of the pattern. From there, you can work out which wave the market is currently in and make predictions about where it might head next.

The Relative Strength Index (RSI) is another indicator that is helpful alongside the Elliott Wave Theory as it can be used to measure the strength of the trend and to identify potential reversals.

Triangles are a correction five-wave pattern (marked as A-B-C-D-E), which is divided into five types. This pattern is formed in a position prior to the final wave in an impulse or a correction. For example, a triangle could be formed in a wave four in an impulse or wave B in a zigzag.

How accurate is Elliott Wave Theory? ›

That will rarely provide an accurate analysis of market sentiment, and when most of the projections based upon this type of “analysis” fail, one can now understand why. Many also take issue with the fact that Elliott Wave analysis suggests you maintain both a primary analysis, as well as an alternative analysis.

Elliott waves are used in technical analysis to determine price movements. Elliott's Wave Theory mainly comprises two kinds of waves – motive (impulse waves) and corrective waves. A motive wave consists of five waves – three impulse waves and two retrace waves.

A simple way to answer is to say that light is a type of wave that causes objects to be visible to human eyes. The sun produces light, and that light bounces off objects and into our eyes. This makes it so that we can see things, because the brain can interpret that light and tell us what's out there.

The Dow Theory attempts to identify the primary trend a market is in. It is comprised of three primary trends, each made up of secondary and minor trends. The theory assumes that the market already has knowledge of every possible factor and that prices reflect current information.

The Elliott wave zigzag rules are essential for understanding and identifying this formation in market trends. The main rule is the '5-3-5' sequence. The first wave, 'A', is made up of five smaller ones, followed by wave 'B' consisting of three smaller ones, and finally, wave 'C' with five smaller waves.