Elliot waves, like Fibonacci levels, are another example of using patterns that occur frequently in nature to predict the movement of the forex market.  Elliot waves use fractal patterns and like fibonnaci levels, fractal patterns occur frequently in nature.  Fractals are patterns where part of the pattern is similar to the whole creating an increasingly detailed pattern based on a simple self-repetition.  Common examples are fern leaves where a fern leaf is made up of smaller leafs that look like the whole, which again is made of smaller leafs.  Snowflakes and coastlines are frequently quoted as examples of self-similarity.

Since the forex market is governed by the psychology of millions of human investors buying and selling currencies the market as a whole.  According to the Elliot wave theory the crowd psychology of the forex market moves between periods of optimism and pessimism in predictable waves.

The Elliot wave model  predicts that the market will move in sets of “impulsive” waves, which form the main trend, followed by a set of corrective waves.  The main impulsive wave itself will be broken into a set of smaller impulse and corrective waves.

The 5-3 wave

The first set of implusive waves is comprised of 5 waves.  These waves are numbered 1 -5 as below.

The corrective wave is comprised of 3 waves.  These waves are labelled with the letters ABC.

Elliot wave rules

There are 3 rules to correctly count Elliot waves

1 Wave 2 cannot retrace beyond the start of wave 1

2 Wave 3 cannot be the shortest wave

3 Wave 4 cannot overlap in the same price territory of wave 1

Wave timelines

The timeframes of Elliot waves are called degrees.  The shortest of which occur on a minute to minute scale.  The completed set of 5-3 waves on the minute scale would comprise the first wave and correction (i.e wave 1 and 2) on the next degree up ( the hour degree).  Once this set completes it would comprise the start of the 5-3 wave of the next degree up and so on ad infinitum.

These degrees have been labelled

Grand supercycle: multi-century

Supercycle: multi-decade

Cycle: one year to several years

Primary: a few months to a couple of years

Intermediate: weeks to months

Minor: weeks

Minute: days

Minuette: hours

Subminuette: minutes

Fibonacci and Elliot waves

Given that Elliot waves rely on the patterns created by mass crowd psychology, it shouldn’t be very surprising that there is an overlap with Fibonacci retracement patterns.  Fibonacci retracement levels  are often used with Elliot wave theory to predict the size of corrective waves as corrective waves frequently bounce off Fibonacci retracement levels.