Riding the Elliott Waves

In the 1930's, an accountant named Ralph Nelson Elliott put forward what was then a radical idea. He proposed that markets - including the forex market, though he didn't mention it explicitly - move predictably because buyers and sellers act in a predictable manner as well. His idea became known as the Elliott Wave theory or the Elliott Wave principle and has become a fundamental idea in the study of markets and investor behavior. According to Elliott, any movement in the market happens in a series of waves, known as Elliott waves, each one a phase with distinct characteristics.

The first Elliott wave in the five-wave pattern is usually the least noticeable. It represents the initial move of the stock or of the commodity upwards. This wave is often caused by just a limited number of people who, for one reason or another, decide to invest or buy forex. Their actions eventually cause the prices to rise.

The second wave of the five-wave pattern obviously follows the first one, and is usually caused by people selling off stock or currencies, or otherwise reconsidering the decision they made during the time of the first wave. This spate of selling causes prices to decline once more. However, since not everybody sells off the shares or the currencies that they purchased, the price doesn't reach as low a point as when it started out.

The third wave is oftentimes the largest and most dominant of all five, and it goes hand in hand with Elliott's beliefs on people and the natural herding instinct, even when investing. The third wave represents the time when the public or the mass market hears about the stock, currency or commodity and suddenly takes interest. This is usually influenced by the initial interest shown by the investors of the first wave. A lot of buying and selling activity happens during the third wave, and the price nearly always reaches a peak that surpasses that of the first wave.

The fourth wave shows a brief dip in the prices of the stocks, currency or commodity. This is caused by the choice of some individuals to sell while the price is at a high point and thus make a profit. This wave is, as has been mentioned, very short.

The fifth wave, like the third wave, goes hand in hand with Elliott's idea of the herding instinct in investing. The news and the public views about the stock, currency or commodity are already widespread and almost completely positive by this point. The buying activity in this wave is mostly fueled by hype, and this is the time when many average investors decide to join the bandwagon. This wave usually contains the highest point of the price of the stock, commodity or currency.

Elliott's idea hasn't been universally accepted to this day and many still refute it. The concept is, nonetheless, based on reasonable premises and has been proven to apply to many cases.

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The Elliott Wave principle or the Elliott Wave theory is a concept that divides any major market movement into five waves or phases. It has long been held that this idea can apply to the forex market as well, and should be of interest to forex investors.