Elliott Wave Theory is a technical analysis approach that is based on the belief in cycles in the mass psychology of investing.
According to Elliott Wave Theory, financial markets follow a familiar pattern of successively smaller 5-3 waves, with the 5 on-trend waves being interspersed with 3 opposite-trend counter-waves.
Within each wave of the larger trend is a smaller 5-3 wave-set that takes place at a faster rate yet with less magnitude. These successively smaller wave sets continue on infinitely until their impact is no longer noticeable in effective trading terms, though they will still exist mathematically.
Elliott Wave Theory In Technical Analysis
Elliott waves are another common technical analysis tool that exists largely in the eye of the beholder.
There are common measures for what constitutes a ‘wave’ as proportional to relevant surrounding price action, but it is ultimately up to the individual trader to decide when a wave starts or ends before applying more objective measures.
Elliott Wave Theory & Day Trading
Day traders use Elliott Wave Theory to make predictions about upcoming price action. Since Elliott Wave Theory predicts repeated on-trend waves, periodic counter-trend waves and successively smaller wave-sets, it can be used in a wide variety of ways to create effective trading positions based on resulting predictions.
The most difficult part of successfully applying Elliott Wave Theory to trading is correctly identifying the current location on a proposed wave-set.
Once this has been established, however, Elliott Wave Theory makes clear and strong predictions about the future direction of prices. Day traders need only decide how to effectively trade given the current location on the fixed wave pattern.
Final Thoughts
Elliott Wave Theory has a long history of being used as a rough technical analysis tool for predicting the general direction of upcoming price movements.
Much of investment theory is based on the underlying belief in clear, repetitive patterns to the mass psychology of investors, and Elliot Wave Theory is one of the most popular and long-lasting examples.