Traders have different approaches to the Forex market. Some use fundamental analysis, or the interpretation of economic and geopolitical data, to position themselves as buyers or sellers of a currency pair.
For example, if the economic data in the Euro area is far better than the US data, then these traders are inclined to buy the EUR/USD – expressing a bullish position.
Some other traders use technical analysis.
Technical analysis has many areas – classic patterns, Japanese candlesticks, and trading theories.
Elliott Waves is the most famous trading theory, and it reflects how online Forex trading revolutionizes the market participants’ view about future prices.
Impulsive and Corrective Waves
Ralph Elliott started by dividing market movements into two categories – impulsive and corrective. An impulsive was is also called a five-wave structure because Elliott discovered it has five different segments. Also, for impulsive waves, he used numbers – 1-2-3-4-5.
Corrective waves are called three-wave structures, even though some, like triangles, have five segments. For corrective waves, the Elliott trader uses letters.
Different types of impulsive waves exist, too, such as classic or terminal. But Elliott focused on corrective waves, as markets tend to take more time consolidating.
Simple and Complex Corrections
A corrective wave is a reaction to an impulsive one. Elliott believed that financial markets move in cycles and that cycles are of various degrees.
A cycle is made of an impulsive and a corrective wave. Corrections, he found out, can be either simple or complex ones.
Three basic simple corrections exist – flats, zigzags, and triangles. The first two are labelled as a-b-c, while a triangle is labelled as a-b-c-d-e.
A full cycle, therefore, is labelled as 1-2-3-4-5-a-b-c.
The theory becomes more complex when interpreting the different types of corrective waves. Complex corrections do exist, such as double and triple combinations or double or triple three running patterns. This is why, to fully master the Elliott Waves theory, traders need to dedicate a lot of time and practice counting on different markets.
Another key characteristic of the Elliott Waves theory is that it uses top/down analysis. Effectively, it mean that the analysis starts from the larger timeframes and continues to the smaller ones right from where the analysis ended.
In other words, it starts from the monthly charts or even a larger timeframe, and looks at different cycles. Naturally, nobody trades the monthly chart, but by the time the top/down analysis continues and reaches the daily timeframe, this can already be traded.
By combining impulsive and corrective waves, Elliott made sense of different market cycles of various degrees. Nowadays, the Elliott Waves theory is used extensively as online trading gives access to historical data as well as to trading platforms that make counting waves much easier than in the past.