The Elliot wave theory is based off the publishing's of Ralph Nelson Elliot from the 1930s, which states that all prices have a typical pattern that they follow. These patterns not only are found in chart patterns but also all throughout nature, as stated in his thesis. The pattern is broken down into five stages shown in the chart below.
Elliot states that the reason behind this pattern is that people first catch on to a trend, then sell off after prices have risen. After that more people will catch on and later sell, and buy again. According to him, this cycle repeats itself on a continuous basis and on different scales as well. For example, these patterns could be occurring on minute-to-minute basis as well as a decade-to-decade basis at the same time.
Waves 1, 3, and 5 are known as impulse waves, while waves 2 and 4 are known as corrective waves.
According to the theory, since the waves continuously repeat themselves, the pattern can be used to predict future price changes.
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