Elliott Wave Theory – Background

The Elliott wave theory was born from a set of articles written in the 1930s by R. N. Elliott, from his studies mainly on the Dow Jones Industrials index – the U.S. Stock Market. He noticed that the market tended to move in certain patterns.  He then surmised that these patterns could be used to predict certain future price movements. In essence, he noticed that most strong trends tended to unfold in 5 waves in the direction of the main trend, and which were connected by certain corrective patterns.

He also noticed that when each pattern was complete, it then formed part of a larger-degree pattern.  He also surmised that each pattern not only unfolded as part of a larger-degree pattern but also sub-divided into a minor pattern where the impulsive swings (the ones in the direction of the main trend) tended to unfold in 5 waves connected by corrective patterns (the simplest of which was the ABC). He then surmised that if a market analyst pinpointed where in this pattern the market currently was, then he (or she) should be able to predict where the market would go from here.  In essence, the Elliott wave theory allowed you to predict future market movements.

This is very different from many technical analysis techniques available today, where most of them are lagging indicators that show you when a market turn has unfolded in the past.  Elliott wave theory is designed to be predictive in nature and as such should be considered a leading indicator, with the future movement of a market able to be anticipated, once the current position is established. So, if you were able to determine accurately where in this current pattern you are, the Elliott wave theory should then be able to predict where the market should go in the future…….