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Using technical analysis techniques based on Elliott Wave Theory can be a valuable way to analyze the forex market. Basically, a forex trader skilled in applying Elliott Wave Theory can obtain directional guidance, reasonable price objectives and clear stop-loss levels from a detailed analysis.
Not only can such traders gain market insights that no other analytic technique can offer, but the fractal nature of the Theory means they can even make market forecasts for a variety of different time frames. Furthermore, many traders do not realize they already use a technique based on Elliott Wave Theory when they compute Fibonacci retracement and projection objectives.
The Basics of Elliot Wave Theory
In expounding his traditional Wave Theory, R.N. Elliott proposed that a series of five waves were typically observed in market trends. He numbered these waves one through five, where the odd-numbered waves that furthered the trend were called impulses, while the even-numbered waves that moved against the trend were called corrections.
- Zig-Zags - sharp three-wave corrections with a 5-3-5 wave internal structure.
- Flats – more consolidative three-wave corrections with a 3-3-5 structure.
- Triangles – consolidative five-wave corrections with a 3-3-3-3-3 structure.
Overall, this results in a classic eight-wave sequence of trend and correction that Elliott postulated played itself out over and over again on a cyclical basis for both long and short time frames as the market progressed over time.
Furthermore, since Elliott and those using his Theory generally first look at market activity and then “count” waves to see where the market is unfolding in this sequence, analysts commonly refer to this as a “wave count.”
Fibonacci Retracements and Projections
Elliott later enhanced his Wave Theory by using ratios based on the famous Fibonacci sequence to calculate likely correction targets for market retracements and to project probable objectives for impulses. Collectively, traders now refer to these as Fibonacci retracement and projection levels.
For determining likely retracement targets, analysts now commonly use ratios of 1:0.236, 1:0.382, 1:0.500, 1:0.618 and 1:1.764. The 1 represents the initial move now subject to correction.
For computing projection targets, analysts often use ratios of 1:1, 1:1.236, 1:1.382, 1:1.618, 1.764, 1:2, and so on. The 1 refers to the length of the initial move to be followed by another move with a length related to the first by a Fibonacci ratio.
Putting Elliott’s Wave Theory Into Practice
- First review exchange rate movements seen in the target currency pair over the time frame they have an interest in analyzing watching for completed three- or five-wave sequences that can yield a starting point.
- Compile a series of possible alternative wave counts that take into account the observed exchange rate activity.
- Look for any incomplete structures, and compute target Fibonacci retracement objectives and projections as appropriate.
- Wait until one wave count emerges as a high-probability scenario from which to project future market action and then use this count to influence their trading.
Overall, applying Elliott Wave Theory when trading forex means carefully reviewing the forex charts of the currency pairs you want to trade, and waiting patiently for a clear wave count picture to arise. Only then will using this advanced technical analysis technique give you the ability to foresee the market’s future that so many traders seek.
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