Elliot Wave Principle is a theory about mass psychology that is applied to financial markets. This principle suggests that mass psychology is swinging from pessimism to optimism in a cyclical and therefore predictable wave pattern. This pattern is seen in price movements.
The Elliot Wave theory was formulated by a great accountant named Ralph Nelson Elliott. According to his principle, there’s a definite pattern in stock market and there’s no undefined pattern to determine the market. These patterns involve a lot of human psychology. Investors can predict these patterns because they are repetitive. If you can monitor these patterns, they’ll you will be able to predict the behaviour of the market.
There are two different patterns that form the Elliot Wave theory and they are the impulsive and compulsive patterns.
The impulsive pattern is when the trend in the market is positive and the share value goes up. On the other hand, the pattern is compulsive when the trend is negative and the market value falls. You can predict the behaviour of the market if you can determine where the exact value is.
The 5-3 wave pattern explains the Elliot Wave theory. 1-5 wave pattern represents the 5 impulsive and wave pattern a-c represents the 3 compulsive. If you understand the pattern, then you’ll find exactly when to buy and sell shares so you can easily mint money in the share market.
1,3 and 5 is called impulsive while 2 and 4 is called corrective. In Wave 1, the stock is moving upwards. People will easily notice it. When it reached a certain amount of money, people will then sell it for profit. This is what causes the dip in the peak. Hence, forming the wave. More people waits for that particular stock to go down so they’ll be able to buy it. This is what causes the upward movement and hence the wave 3. This wave keeps on rising. More people will notice it. Traders will then sell the stock and make huge profit out of it. This then causes the stock to fall again which forms the wave 4. More investors now are waiting for the dip so they can buy the stock. Once that it has reached the limit, more investors will then buy stocks which results in the increase of the stock value.
The corrective waves come into the picture when the stock reached its peak. A, B and C denotes these corrective waves. This can be 21 different patterns. These ensures that the stock will go back to the impulsive wave pattern 1. We’re talking about the bull pattern which starts with the upward trend. However, there could also be a bear pattern where the trend is downward.
All these waves have sub waves. These sub waves are formed by the same 5-3 wave patterns. If you can determine the wave where the market is at, then you can easily predict the behaviour of the market. When implementing this theory, one should remember these 3 rules.
• Wave 2 cannot fall beyond wave 1
• Wave 3 cannot be smaller than any of the impulsive waves
• Wave 3 cannot be same as wave 1
Keep these 3 principles in mind when determining the market share position.