Wave theory

The creator of wave analysis, R. Elliot, was an accountant by profession. Due to his health, he was forced to retire early and undergo a long course of treatment. For a long period of restoring health, he began developing his own theory of market analysis, inspired by the ideas of Charles Dow. R. Elliott outlined his theory in a series of twelve articles published in 1939. He also wrote books on wave theory. Elliot in his work considered the wave theory as a comprehensive, fundamental principle of the universe, and not only as a way to analyze financial markets (in his example, he demonstrated the principle of the theory). The theory gained its popularity thanks to E. Bolton, who published fourteen years of work on the theory of waves, and E. Frost, who devoted one of his major studies to wave theory.
The basic concepts of wave theory are model, ratio, and time.
A model is a configuration that a combination of waves takes. By measuring the relationships between different waves, the levels of correction and price targets are determined. Temporal relationships are used to confirm wave patterns and the ratio of the waves.
The wave theory was originally developed for use in stock markets and read:
the stock market is subject to a repetitive rhythm: five waves of growth, three waves of falling
In the growth period consisting of five waves, there are both ascending and descending waves. Rising waves are called pulsed, descending - corrective.
Elliot tested his theory at various time intervals and came to the conclusion that the trend is always evolving according to the basic eight-wave principle. When considering long periods, it becomes clear that large waves simply break up into smaller ones, which in turn break up into even smaller ones. Waves break into three or five smaller waves. The number of smaller waves into which a big wave breaks depends on the direction of the trend in which this wave is located. Therefore, by observing how much smaller waves a big wave breaks in, one can predict the direction of the trend.
The ability to analyze the number of waves can also predict the duration of the trend or correction. So, knowing that the correction cannot consist of five waves, in the presence of a five-wave dip, one can say that this dip will continue.
To analyze the waves, it is necessary to know the individual characteristics of each wave.
The first wave, the shortest, is a “rebound” from the lowest levels.
The second wave is held above the base of the first wave and often leads to the formation of various technical analysis figures, for example, the head-shoulders figure. The second wave is the correction phase.
The longest and most dynamic is the third wave, which accounts for the largest volume of trade. During the third wave many gaps appear on the graphs.
The fourth wave, like the second, relates to the correction phase. During the fourth wave, triangles often appear on the graphs.
The fifth wave is less dynamic than the third. Many technical indicators begin to lag behind the price movement during the fifth wave.
The sixth, seventh and eighth waves (or waves A, B and C) refer to the period of the fall. Wave A corresponds to the correction phase. The movement of prices during wave A is only indicative of a retreat downward with a general upward trend. If wave A is divided into five smaller waves, we can talk about a change in trend.
Wave B refers to a new downtrend, but shows a “rebound” in prices upwards.
And, finally, wave C makes it possible to say with complete confidence that the upward trend is over. Often, wave C drops well below the base of wave A.
Undoubtedly, the ability to apply the Elliot wave theory requires a more detailed acquaintance. You can get acquainted in detail with the principles of the theory of waves by reading the following books:
R. Elliot "The law of nature - the main secret of the universe",
E. Bolton "The principle of Elliot waves - a critical analysis",
E. Frost, The Elliott Wave Principle.