Knowledgeable investors and traders often turn to technical analysis because it helps them identify trading opportunities within securities and other financial instruments. This approach’s essential and efficient tool is the Elliott wave theory developed by Ralph Nelson Elliott (1871-1948).
The Elliott wave theory is widely used in Hong Kong by investors and traders in the futures, options and equities markets. Many analysts believe that this tool can help predict the short-term direction of the market and its long-term trend. The Elliott wave theory is based on market psychology, which drives investor sentiment and, ultimately, price movements.
What is the Elliott Wave Theory?
Underpinning the Elliott wave theory, prices trend over time, forming many small waves in one direction followed by a correction against the trend. When applied sequentially, these corrective moves produce five waves, creating an “Elliott five-wave sequence”.
The overall cycle then consists of three such sequences following each other, resulting in a complete cycle of eight waves. This observation led Ralph Nelson Elliott to postulate that these waves followed a natural pattern and could be used to predict future price movements.
Key principles when using the Elliott Wave Theory
You need to remember some fundamental principles when using the Elliott wave theory.
1) Waves form and correct against the primary trend.
2) Wave 2 should never retrace more than 100% of Wave 13) Wave 4 should not break the trend of Wave 1.
4) Waves are configured in five wave sequences;
- Three impulse waves in sequence, each separated by a corrective wave
- Corrective waves form three different types: zigzag, flat and triangle.
5) The use of Fibonacci retracement levels can help identify points that could be either support or resistance levels.
Pros and Cons of using the Elliott Wave Theory
The SEHK made their debut on Bloomberg’s global screen in 1989; only 20% per cent of all securities transactions were taking place electronically. Two decades later, electronic trading now accounts for more than 95% of all transactions on the SEHK.
It can be an effective tool for market prediction for investors and traders using the Elliot wave theory. It is as part of their technical analysis. This includes helping to establish future price targets and suitable entry and exit points for trades. However, it is vital to keep in mind this approach has been subject to criticism from academics who argue that the theory is based more on psychological trends than market data analysis, making it challenging to apply in practice.
Famous for its ability to successfully predict market trends, the wave theory suggests that markets express themselves through a repetitive cycle of five waves followed by three corrective waves. As such, this cycle applies not only to stocks and stock indices but also to commodities and currencies alike.
There are, of course, sceptics of every investment concept, and the Elliott Wave Theory is no exception. Some market analysts who have been observing the Hong Kong market for years believe that the waves don’t exist here. They further claim that most moves in the Hang Seng can be better explained by basic supply and demand forces and that cycles can be found in any data series if looked at hard enough.
At the end of the day, whether or not you believe in the Elliott Wave Theory is up to you. What matters more is how you use it and if you’re willing to heed the warnings and take advantage of this theory’s opportunities.
Investors who are new to the Elliot wave theory, it helps to experiment with this approach using a demo account before trading with real money. This allows you to understand all the intricacies involved without endangering your capital. Following this advice will help you avoid the many pitfalls of this tool and successfully integrate it into your technical analysis. Contact a reputable online broker from Saxo Bank and start your investment journey if you want to start trading stocks using the Elliot Wave Theory.