When you evaluate the Forex market for the swing trade opportunities, the focus of consideration is to predict the continuations and directional changes for certain given pair of currency, and for this purpose; most of the times people rely on technical analysis. In such an analysis, for instance, the fundamental analysis, there are leading and lagging indicators.
One of the most reliable analysis tools in this regards, that is used to predict the Forex market swings is termed as Elliot Wave Theory analysis. It can be used to classify the trends as well as counter-trends, continuation and exhaustion trends and last but not the least, to evaluate the potential price targets of any trend. Elliot Wave analysis can be used to predict both, short as well as long term swing trade set up for the currency pairs.
The Elliot Wave Theory:
The Elliot Wave Theory was presented by Ralph Nelson Elliot. He said that the stock market moves in cyclic or waves patterns that are based on the psychology of the traders. It can be put in other words as it is the mass psychology of time that shapes up the movements in the market. He also said that the market is a fractal. Fractal is basically an object that has the same shape at different scales. It can be understood with the help of an example, for instance, we talk about the stock of broccoli. The stalk, as well as individual branches, appear to be exactly same but in fact, the branches are smaller in scale.
Talking about Elliot’s Theory again, it states that emotional patterns tend to repeat them over the period of time.
The sequence of Elliot’s Wave Theory:
Elliot’s Wave patterns follow a sequence where the market moves up in a series 3 waves and down in series 2 waves. This impulse of 3 waves and 2 wave corrective sequence forms the foundation of the 5 wave impulse pattern. Opposite to it is true when there are downtrends in the market.
Elliot’s wave count is as follows:
Wave 1 is short covering, 2 is a pullback from short-covering, 3 is a phase of major rally, wave 4 is the institution pause in the rally, 5 is the retail buying.
It is the weakest impulse wave. It is brief and based on the short covering of the bears. When this wave is completed, the currency pairs are sold off creating the wave 2.
This wave ends when the market fails to make the new lows. Dominant reversal patterns are formed at the end of this wave and point towards the Wave 3.
It is the strongest and the longest impulse waves. It signals towards the buying and selling of the currency in the direction of the trends. These trends usually start slowly but then accelerate and break to the new highs that are above the top wave 1.
Just like any other trends, the correction will occur even here to take the profit while currency pairs will be retracted. It is a signal that wave 4 is about to begin.
Once again the currency pair rally in the Wave 5. It is usually supported by the non-institutional buyers i.e. the herd, and the retail traders. It tends to slow down the momentum generated in the Wave 3 rally. This divergence can be measured with the help of a technical oscillator. Once the currency pair breaks to new high that is above the Wave 3 high, the rally loses the steam and hence changes the trend. This change in the trend can lead to either a new 5 wave impulse patterns that can even be corrective in nature. This is how the Elliot Wave Analysis is carried out.
Conclusion of the Elliot Wave Theory:
The conclusion of the Elliot Wave Theory is that market price actions are not because of the growth or slowing down of the economy but it is actually the refection of the psychology of the investors. If the mood of the investor is upbeat then the market will experience bull trends. This is something opposite to what is usually perceived that as there is a bull trend in the market, the mood of the investors is positive.