Why should you care about Elliott Wave Theory?
Elliott Wave Theory is used to predict where a market is headed, so you can make more educated decisions on when to buy or sell an asset. While Elliott Wave Theory, EWT for short, can be intimidating and hard to understand, just knowing the basics can help you make more educated trades.
Terms to know
Impulse wave: an impulse wave is a movement in price of a stock/crypto that follows the direction of the larger market trend.
Corrective wave: a corrective wave is a movement in price of a stock/crypto that moves in the opposite direction of the larger market trend.
Wave: a wave is a significant movement in the price of a stock or cryptocurrency either up or down.
Sub-wave: a sub-wave is a smaller movement in price relative to a larger time scale or larger price movement. Think of this as “a wave inside a wave”.
Major wave: a major wave is a larger movement in price of a stock or cryptocurrency relative to the timescale being discussed. Think of this as “a larger wave made up of other waves”.
What is Elliott Wave Theory?
Elliott wave theory is a technical analysis indicator based on crowd psychology. Each wave consists of five sub-waves, and each set of sub-waves follows a similar set of patterns. The five sub-wave set includes two corrective waves and three impulse waves. Impulse waves follow the same direction, up or down, as the major wave, and corrective waves go the opposite direction. Below shows a typical set of impulse and corrective waves in both a bullish and bearish scenario:
In both of these scenarios, the corrective waves are shown in red and the impulse waves are shown in green. Impulse waves move with the general trend of the graph, and corrective waves move the opposite way of the trend. These are typical patterns used to predict markets using Elliott Wave Theory. After these five sub-waves, there is typically a movement in the opposite direction with three movements. These movements are labeled as “a”, “b”, and “c” below. If you are able to recognize the patterns shown below, you may have the edge needed to be profitable while trading cryptocurrencies in the current bear market.
Why is EWT so important in cryptocurrency?
As mentioned before, Elliott Wave Theory is based off of crowd psychology. Due to much of cryptocurrency’s evaluation being based on speculation, psychology plays a huge role in the market. Below are some great examples of EWT from recent charts of Ethereum and Bitcoin.
Rules for Elliott Wave Theory
Elliott Wave Theory is fractal, meaning smaller waves follow the same patterns as larger cycles. This means that within the impulse wave 3 above there is a five-wave subset that follows the Elliott Wave pattern.
The simplified chart to the above shows a smaller scale of EWT within a larger impulse wave 3. The sub-waves of the impulse wave are labeled in lowercase roman numerals, and the larger impulse wave is labeled as “3”.
Another rule that EWT follows is that the third wave, an impulse wave, can never be the shortest impulse wave in the set of eight waves. In fact, wave 3 is often the largest wave in the set. Occasionally, the fifth wave will become an extended fifth wave, and it will be longer than the third impulse movement. Additionally, the corrective waves 2 and 4 will never go lower than the start of the impulse wave before it. If a corrective wave does go lower than the previous wave, then an EWT count is invalidated. Also, the fourth wave, a corrective movement, cannot move below the top of the first impulse movement (sub-wave 1).
Remember, practice makes perfect. Go ahead and look at past price movements in a cryptocurrency or stock you follow and try to see if you can find applications of EWT. Soon enough you will be able to recognize these trends to predict where the market is headed!