The Elliott Wave Theory (“EWT”) is a technical analysis technique based on crowd psychology. Inspired by the Dow Theory, his founder Elliott mantained that the movement of financial markets could be predicted by observing and identifying a repetitive pattern of waves. He believed that markets tends to follow a repeating pattern, driven by crowd psychology.
Regardless of the changes taking place in market conditions, EWT suggests that traders were ultimately repeating the same boom and bust cycle over and over again and that all of man’s activities were influenced by these identifiable series of waves. The underlying forces behind the EWT are of building up and tearing down.
EWT may be summarized by the following famous motto: any action is followed by a reaction.
There are 5 waves in the direction of the main trend followed by 3 corrective waves (a “5-3” move). A 5-3 move completes a cycle. This 5-3 move then becomes two subdivisions of the next higher 5-3 wave. The underlying 5-3 pattern remains constant, though the time span of each may vary. The basic pattern is made up of eight waves (five up and three down): 1, 2, 3, 4, 5, a, b, and c. Waves 1, 3, and 5 are called impulse waves. Waves 2 and 4 are called corrective waves. Waves a, b, and c correct the main trend made by waves 1 through 5.
The main trend is established by waves 1 through 5 and can be either up or down. Waves a, b, and c always move in the opposite direction of waves 1 through 5. EWT supposes that public sentiment and mass psychology move in 5 waves within a primary trend, and 3 waves in a countertrend.
Once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of “news.”
The EWT supposes also that each wave within a wave count contains a complete 5-3 wave count of a smaller cycle. The longest wave count is called the Grand Supercycle. Grand Supercycle waves are comprised of Supercycles, and Supercycles are comprised of Cycles. This process continues into Primary, Intermediate, Minute, Minuette, and Sub-Minuette waves.