Introduction to Forex Elliott Wave Analysis
Reading time: 8 minutes
Most Forex traders base their decisions on technical analysis. This type of analysis identifies market patterns and trends based on complex mathematical equations, which are combined and placed into the form of a certain indicator. Various traders employ different indicators in their trading setups, yet there are some indicators that are more commonly used.
Elliott Waves (often abbreviated to EW) is one of these well known indicators. It is so popular that it actually occupies its own niche in Forex trading analysis. In this article, we will provide an overview of the history of the indicator and its development, and we will also explain how to use it. We will then discuss how to apply the EW oscillator, while supplying you with useful links for further reading about wave analysis.
Elliot Wave Analysis History
Ralph Nelson Elliott was the founder of this theory, and invented the Elliott Wave mechanism. This term refers to the particular pattern or trend followed by the stock market, which occurs in repetitive in trade cycles. It all started in the 1930s when Ralph Nelson Elliott highlighted specific patterns of market prices.
From this work, market practitioners came up with the name Elliott Wave. This methodology is not about calculations; rather, it looks at the historical trends of the financial markets, working on the premise that history repeats itself. With this in mind, advocates of this theory believe that a comprehensive presentation of the market can be represented with the help of wave analysis in Forex.
So why do these repetitive trade cycles occur? It's because of the mass psychology of the financial markets. Investors that trade within these markets broadly share the same hopes and anxieties, meaning that they often react as a 'herd' to economic news events. As a result, prices within these financial markets - including Forex - suffer from upward and downward swings known as waves.
Elliott Waves show that investor psychology is the real engine behind movements within the financial markets. This is why it is used in Forex trading - to produce more understandable and profitable results. The process of applying Elliott Waves to trade the Forex markets is also known as Elliott wave analysis or Forex wave analysis. Forex Elliott wave is often used by traders and Forex investors as one of many Forex advanced strategies. Broadly speaking, here is how many professionals approach EW in Forex trading:
- Selecting a particular method of generating Elliott Wave count
- Waiting until the Elliott Wave gets '5'
- Confirmation of the trends from indicator(s)
- Finalising a stop-loss point
- Entering Forex trading and placing a stop-loss order
- Considering optimum profits and stops
- Deciding upon a trade exit plan in case of losses
Hence, Forex Elliott Wave analysis can affect Forex trading in a myriad of ways. This means that there are multiple ways to interpret Elliott Wave analysis. It depends on the requirements, and the choices of the Forex trader, as to which method of FX wave analysis they follow.
Usage of EW
Source: GBP/USD 4 Hour Chart - How to use Elliot Wave Analysis
Having said that, it does not matter all that much which variation of Forex Elliott Wave analysis a trader follows. What matters is their ability to attentively follow its trading rules, which include:
- To design or frame a reliable technique for interpreting the current Elliott Wave count
- To ensure a valid trade signal through appropriate filters duly employed when trading Elliott Wave analysis
- To decide a proper stop-loss point
- To attempt to make profits from the first batch of waves, and then view the last waves as extra opportunities that have a higher chance of resulting in a stop-loss
Learning EW Analysis
Experts have always encountered difficult periods when trading with Elliott Wave analysis. The high degree of subjectivity involved in applying this methodology is most probably the reason for its mixed success rate. This is the reason why it is strongly advised to learn Elliott Wave Forex analysis in some detail.
Types of waves
The Elliott Wave analysis Forex includes two different wave patterns, which include the five wave pattern, as well as the three wave pattern. The five wave pattern can be found with five different dominant waves, which include Wave 1, Wave 2, Wave 3, Wave 4, as well as Wave 5. The other corrective trend includes the other three wave patterns, including Wave A, Wave B, as well as Wave C. All of these waves make up for arranging the best results in market analysis.
Principles of waves
There are certain principles that come up with the influene of Elliott Wave Forex analysis. Some of them are mentioned below:
- There are three impulsive waves Wave 1, Wave 3 and Wave 5, out of which Wave 3 can never be the shortest
- The retraction which comes from Wave 2 is not more than 100% of Wave 1
- Wave 4 will never overlap Wave 1 in the price territory
- All will be diagonal in the case of a diagonal triangle
Are Elliott Waves Useful?
It goes without saying that this indicator can be useful for many traders. Yet it is important to understand that it is still just a theory that is not proven. This is why there are many traders that simply disregard EW within their trading strategy. Nevertheless, EW has been an important indicator not only in Forex analysis, but also in stock trading. EW may not necessarily be beneficial for you, but you can only find out through the application of it within your trading strategy.
But how can traders combine EW with other Forex indicators? In general, EW is just a supportive indicator that can provide you with a good overview of the market and its potential moves, along with the correct placement of stop-losses and take-profits. However, it does not provide exact entry and exit signals. This is why this supportive indicator is recommended to be used together with other indicators that can be used for identifying the points of entering and exiting the trades. Hence, EW should be used for confirmation rather than identification.
The MACD (Moving Average Convergence Divergence) is one of the most popular indicators for beginner traders. The good news is that it goes quite well with EW. The best application of the combination of these indicators is by monitoring the appearance of the third wave of Elliott. Another great and easy indicator that goes well with the Elliot Wave is the Relative Strength Index (RSI). With the combination of these indicators, you can predict how strong the future moves could be.
Elliot Wave Analysis in MetaTrader
If you are trading Forex, your trading platform is most likely MetaTrader. Here we are going to explain where to find EW within MetaTrader 4 and how to apply it. As a rule, you would need to have a MetaTrader 4 account before you can actually apply the EW. If you don't have one, apply for a demo trading account to gain access to an account preloaded with virtual money. Once you have downloaded and installed MetaTrader 4, you need to login to the platform. After that, you would need to select 'Indicators', and then choose 'Oscillators'. Under this category, you will be able to find EW.
Analysis of market behaviour can never be made easier with Forex Elliott Wave analysis alone. So the utilisation of statistics, with the help of Elliott Wave analysis in Forex trading, is highly recommended. If you are looking for an easy way to confirm market behaviour, make sure you understand Elliott Wave. EW is a great way to boost your knowledge and understanding of Forex trading - and to generally understand the market's behaviour a little better.
The best way to experience practical use of EW is by trying it out on your trading platform. This indicator is not so easy to use, yet it is quite useful to have it as a part of your trading setup. We would not recommend you to solely rely on EW, it should be a secondary or a conformational indicator to an already established trading strategy.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.