One of the most popularly used methods of predicting market trends is the Elliott Wave Theory. This theory was developed by the professional accountant Ralph Nelson Elliott. He developed the theory for decades before finally publishing it in the book The Wave Principle in 1938. The Elliott Wave Theory can be used with any market, including the foreign currency exchange market (Forex).
What is unique about the Elliott Wave Theory is that it uses the psychology of trading to determine trends. Mr. Elliott discovered that markets would change depending on outside influences (like those CNN commentators making predictions). These psychological reactions to a high or low in the market can be used to predict the future growth or decline.
The basic idea of the Elliott Wave Theory is that markets move forward in 5s and then move backwards in 3s. These ups and downs are referred to as waves. Under this theory, Forex traders can catch a high wave and then get out before it goes on a low wave. Or, conversely, a Forex trader will be able to ride a low wave back into a high wave.
During an upwards wave, there are five steps which are broken up into impulses. Impulses 1, 3 and 5 go upwards. Impulses 2 and 4 go downwards. The 1st, 3rd and 5th impulses will last longer than the 2nd and 4th impulses, thus accounting for the upward wave. After the 5th impulse, the downward wave will start. Downward waves occur in impulses of 3s known as the ABC correction. Impulse A goes downwards followed by a brief upward B, then a downward C again.
Of course, the Elliott Wave Theory is not as simple as just waiting out the 5 impulses. The theory is based on the idea of fractals. Fractals are sequences which can be broken into smaller parts and these smaller parts reflect the whole. There are many examples of fractals in nature, such as snow flakes and sea shells. On the small level, you can use the Elliott Wave Theory to track a certain stock or currency but this specificity will also reflect the market as a whole. According to Mr. Elliott, there are 21 corrective ABC patterns and many various formations. It takes a good knowledge of math to correctly use the Elliott Wave Theory.
While the Elliott Wave Theory can be very useful and often accurate, it is difficult to put into practice because it doesn’t specify any timeframe which each of the upwards or downwards waves will last. And, as any skilled Forex trader knows, timing is everything! Each so-called Elliott Wave Theory expert will interpret the trends differently when deciding when to enter the market. When looking at Forex trading waves, it is important to look at the larger picture because, under the Elliott Wave Theory, no wave will fall below the start of the start wave.