In the days of the old school around the 20’s and 30’s, there was this great genius named Ralph Nelson Elliot. Elliot discovered that stock markets do not really work in a chaotic way as was believed.
Elliot discovered that markets operated in repetitive cycles, which were influenced by the emotions of investors and traders, which in turn were influenced by external factors such as economic news or by the predominant psychology of the masses at that time. .
The Elliot Wave theory explains that the upward or downward changes iven by the psychology of the masses always show the same repetitive patterns, which in turn are divided into patterns that he called waves. Hence the name.
Wave patterns 5-3
Elliot showed that a trend market moves in a way that he called: 5-3.
The first 5 are grouped in the impulse wave pattern. And the last 3 are called corrective waves.
This is a short description of what happens during each wave. The Elliot Wave theory was used in the first instance for actions, since it was what Elliot also used, but it does not really matter. They can easily be used with bonds, gold, oil, … The important thing is that this theory can also be applied to the Forex currency market.
The market initially moves up. This is usually because a small group of people suddenly feel (for various reasons, real or imagined) that the price of the stock is very cheap so it is the perfect time to buy. This causes the price to rise.
At this point, enough people who bought according to the previous wave, consider that the stock is overvalued and decide to take profits by selling. This causes the market to go down. However, the market will not reach its lowest previous point before the stock is considered a bargain again.
This is the longest and strongest wave. The action has caught the attention of the public. More people investigate about the action and want to buy it. This causes the price of the stock to rise more and more. This wave usually exceeds the point reached in wave number 1.
People take profits because the price is considered high again. These waves tend to be weak because there are usually more people who are still selling and still waiting to buy in the falls.
This is the point that is handled mainly by hysteria. You usually see the head of the company on the cover of an important magazine where they name him the “character of the year”.