The Elliott Wave Theory And The Predictability Of Human Psychology

For anyone with even a passing interest in stock markets and trading the name Ralph Nelson Elliott is usually a very familiar one. An accountant working at the turn of the last century Elliott's theory, known as the Elliott Wave Theory, proposed that stock market trends and patterns were, to a certain degree, all very much the same.

If you take one stock market chart for something like oil, and you remove all information relating to any timeframe or values, and you place this next to a trading chart for something completely different, what you will notice is that they share significant similarities.

The reason for this, so Elliott Wave Theory suggests, is that stock markets are heavily controlled by human psychology, and human psychology is fairly predictable. For example, if you tell someone not to think of a pink elephant they'll be unable to do anything but picture such a thing, and if you offer to show someone your holiday photos they'll suddenly recall an urgent appointment. We are a pretty predictable bunch at heart.

Knowing this fact, and combining it with the mathematical principles of the Elliott Wave Theory, it is possible to observe trends in the stock markets, and foresee changes in advance of them occurring.

The basic principle of the Elliott Wave Theory is simple. Over a period of minutes, hours, days, weeks, months or even many years, stock markets and similar trends will follow a cyclical wave pattern, most usually considered to consist of three progressive waves, broken by two correctional waves.

So the first wave will be a progressive increase in stock value, followed by a slight correctional decrease. The third wave is usually the most significant and longest period of growth, followed by another corrective decrease before the fifth, usually positive growth period. This five point wave can often be seen whether you examine market trends over the very short term, intermediary term or even long term. In this way it has often be considered to be a fractal based theory.

There are a number of ways in which knowledge and application of Elliott's Wave Theory can be used to both predict stock market trends as well as to provide a certain degree of reassurance during times when values may be decreasing. Understanding that these decreases may well be correctional, and be preceding a subsequent growth period can provide a distinct advantage when trading both over the short and longer term.

One of the problems with the Elliott Wave Theory is that it can be difficult to identify the patterns accurately enough to make significant decisions. However, by following a few simple rules and guidelines, Elliott wave theory can become an extremely powerful tool that can probably tell us more about what is actually happening in the market than any other technical indicator.