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Elliot Wave is Ralph Nelson Elliott’s theory about movements of stocks in stock market. Normally, you attribute stock market movements as being unsystematic and not according to any particular method or rule. However, Elliot discovered that stock movements follow specific repetitive cycles. These cycles have their base in different causes like investor’s emotions due to outside influences, prevailing trend at any particular time, etc. Elliot stresses that difficulties of any investor’s psychology follows a repetitive pattern similar to movement of waves in an ocean.
Ralph Nelson Elliott took help of fractal market conditions. Fractals are mathematical divisions, which keep repeating themselves infinitely. Elliott identifies specific characteristics in wave patterns, which determine market movements. He characterizes an impulsive wave, which forms the main trend. This contains five more waves within its pattern. Further, each of these five waves has another five waves. This smaller and smaller pattern keeps repeating itself until infinity. His ever-smaller wave patterns were wave degrees. However, later scientists identified such small waves as fractals. Elliott’s principle came to fore in the 1920s.
Financial markets normally function according to scientific theory of ‘every action has an equal and opposite reaction’. Therefore, prices of stocks rise and fall in specific patterns and cycles. Such action of prices follows few trends or corrections, which are sideways movements. Elliott named these movements as corrective waves and impulsive waves. Elliott’s theory of waves categorizes five waves in main direction with three corrective waves. This 5-3 move forms a cycle. This forms subdivisions when it moves into next higher 5-3 wave. Therefore, throughout pattern of waves remains 5-3 but time and extent of wave keep changing. Such patterns are applicable to both bearish and bullish markets.
Elliott Wave Theory analyzes waves in descending order as Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, and Sub-Minuette. Elliott Wave’s theory works fine even now but in the long term. Short-term movements of stocks do not follow any specific and particular pattern. Their movements change fast and therefore, you can apply Elliott Wave theory in your long-term stock investments.
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