One particular strategy that is popular among traders, especially price action traders, is the Elliott Wave theory. It was developed in the ‘20s and it is a technical method which aims to identify market cycles and help traders spot trading opportunities in the market.
Elliott came to the conclusion that all market cycles have a fundamental psychological reason and investors react to outside influences or the dominant psychology of the masses at a particular point in time. For those of you that want to learn how to trade using the Elliott Wave theory, you are lucky, because the method is well documented and you can find easily a tone of information online.
According to Elliott, it seems like the crowd behavior evolves in clear trends. And this led him to spot a few price movements in the financial markets that repeat themselves over and over again. In this article we will explain one this pattern that is called the basic 5 wave sequence.
The basic 5 wave sequence
In order to help those that want to learn how to trade, we’ll take an example of a bullish trend, as you can see in our image below.
As can you see from our image above, this pattern has three impulsive moves, labeled as 1, 3 and 5 and two corrective moves, labeled as 2 and 4. To explain a bit the terminology, we call an impulsive move, that type of price movement that heads in the dominant direction of the market. It is that type of move that covers the most ground and that is the direction the “big players” are placing their money. If we talk of corrective move, this type is not heading the dominant direction of the market and the move does not cover a lot of ground. This type of sequence can be spotted often in the market, no matter if we talk about forex, stocks or any other assets.
Understanding the principles behind the Elliott Wave theory can definitely help you have a better understanding on how the financial markets are working, especially how the order flow behind those price movements on your chart is constantly changing and drives prices up and down.