Elliot Wave Theory is a form of technical analysis invented by Ralph Nelson Elliot in the 1930's. The premise of this theory is the belief that stock markets are traded in repetitive patterns, not in a random chaotic manner. By analyzing impulse waves - same direction as the overall trend - and corrective waves - opposite direction of the overall trend - one can predict a stock's future price. Elliot wave theory states that impulse waves have 5 total waves, while corrective waves have only 3 total waves.
There are a lot of rules, but here are the most important ones:
Rule 1 - If wave 2 retraces a lot, then wave 4 will only retrace a lil (vice-versa)
Rule 2 - Wave 4 cannot retrace into wave 1 territory
Rule 3 - Wave 3 is often the longest and never the shortest wave up
If any of these rules are broken then your hypothesis is incorrect. For example, maybe you thought you were analyzing an impulse wave up, but it was actually just part B of a corrective wave - the only rising part of a downtrend. These 3 rules give you a lot of information on the best time to short/long an option or just enter a position in general.
In order to calculate the impulse and corrective waves you have to use Fibonacci Retracements and Extensions, without them it is impossible to use Elliot Wave Theory accurately. Maybe I will attempt to explain Fib Extensions and Retracements in my next random blog post, but they are pretty complicated. Below is a before/after of one of my favorite trades :)
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| Entered position at bottom of Wave 4 |
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| Closed position at top of Wave 5 |
This is a very interesting post on a theory I had not previously heard about. I wonder how accurately it is actually able to predict stock prices based on its rules. I plan on researching this in more detail.
ReplyDelete-Ryan Baer
I hadn't heard about this method of predicting future prices. It's always fascinating to me how you are able to keep track of trends in business to predict future stocks.
ReplyDelete