If you are considering using the Elliott Wave Theory in your CFD trading, be prepared for seeing contradictory opinions and subjective evidence. While the principles espoused by Ralph Elliott appear sound, the matter of their interpretation sparks a great deal of discussion.
The fundamental principles of Elliott Wave Theory state that prices move in waves, which most traders would agree with, and that those waves can be analyzed and anticipated. The main conjecture is that there are impulse waves, which go in the main trend direction, alternated with corrective waves. The other main principle is that of scaling – if you have any experience of the Chaos Theory you may be familiar with this. It states that each wave can be broken down into a group of waves, and each wave of this group can again be expressed as another group of waves, and so on.
To focus on one level of waves for the sake of simplicity, the Elliott Wave Theory says that the impulse wave is composed of five waves, three which go in the direction of the trend, alternating with two in the opposite direction. Elliott was a believer in the Fibonacci sequence as applied to crowd psychology, and so would expect the two in the opposite direction to be a Fibonacci ratio of the main waves, commonly 38%, 50% or possibly 62%. That is, the retracements in the impulse wave would probably be one of those percentages of the main waves.
After the impulse wave, composed of those five waves, there would be a corrective wave going in the opposite direction to the trend, and the corrective wave is composed of three waves, two against the main trend connected by one smaller wave in the trend direction. This sequence of a five wave pattern in the general trend direction followed by a three wave correction pattern would repeat while the trend was in place.
These theories or observations are not rules, and you can certainly see price movements that do not conform to this pattern, or that must be interpreted liberally to make them fit. This is what leads to much discussion, even amongst Elliott Wave practitioners. Many trading groups have been formed and books written on the Elliott Wave Theory, but the difficulty in matching the theoretical to the actual still arouses heated debate.
However, there is no doubt that Elliott’s observations have some merit, and can be used in general without having to fully interpret the details. Counting waves can be problematic, as the question of how large a movement constitutes a separate wave is subjective. But the principle that prices move in waves and that retracements intersperse with the in trend moves is a sound one. To use this knowledge, the strategy is to expect and anticipate that there will be retracements, which may well be a Fibonacci ratio of the main move, and that you can buy on the dip before the trend resumes.
