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Elliot Wave Basics

Elliot Wave Basics

Elliot wave theory is very similar to the candlestick "Three Level Fluctuation" theory. The Japanese detailed the belief that the market typically moves in three defined waves to complete a major trend. Between these three waves, there will be corrective waves. Thus, the Japanese described the Elliot Wave theory hundreds of years before the West became aware of it. So... in the following paragraphs, when I refer to The Elliot Wave Theory or the Three Level Fluctuation Theory, I am refering to both, one and the same so to say.

The Elliot wave theory first teaches us the following.

1. There should be five complete waves with a defined price move.

2. Each wave can consist of a Single Wave, A-B-C Wave or A-B-C-D-E Wave. Thus, any individual wave may consist of any of the three types of wave variations.

3. The peak/valley of wave #3 should be higher/lower than the peak/valley of wave #1.

4. The valley/peak of wave #4 should be higher/lower than the valley/peak of wave #1.

5. Wave #3 and wave #5 are typically the longest/strongest waves.

When traders are attempting to use the Elliot wave theory, one has to remember this is a very subjective type of analysis. If you are able to properly count the waves, they can provide great assistance. Trading waves #3 and #5 can be very exciting and profitable. The problem here is that if it often difficult to properly count the waves as they are forming. This presents a new dilema for traders - how can you rely on the Elliot wave theory if you can't actually rely on the technique as the market is moving??

Here are a couple of tips for traders....

1. Only use the Elliot Wave throry is you are able to correctly could two or more previously completed elliot wave formations.

2. Only attempt to trade Elliot Wave #3 and/or #5. Properly identifying the end of an Elliot Wave 5 count can be risky. Often one thinks the end of the count is now and it actually continues to form an A-B-C or A-B-C-D-E wave - thus creating further losses.

3. The best entry for trading the Elliot Wave patterns is to enter as wave #3 and/or #5 begins. If you wait for the beginning of these waves, you will in effect be waiting for the market to rally or selloff before you get in.

4. Remember to do your homework on the chart before you leap in. Also, use proper money management techniques to protect against unwanted losses.