First, what is the wave theory?
The wave theory is a technical analysis method proposed by American stock analyst Ralph Nelson Elliott, describing the regularity and cyclical price movement patterns in the financial market, and is usually used to analyze and predict medium to long-term market trends.
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The wave theory was originally applied to the study of major stock indices in the USA market, especially the Dow Jones Industrial Index. According to the wave theory, a complete market cycle consists of 8 waves, with each wave representing a specific directional price trend.
Taking a bull market as an example, the characteristics of the 8-wave structure are as follows:
The first 5 waves are the 'impulsive waves', representing the major trend of the market, and are labeled with the numbers 1-5. Among them, wave 1 is upward, wave 2 is downward, wave 3 is upward, wave 4 is downward, and wave 5 is upward.
The 3 waves behind the impulse wave are called the 'correction wave', marked with lowercase letters a, b, c. Among them, wave a is a decline, wave b is a rise, and wave c is a decline.
According to wave theory, the market develops in a pattern of 8 waves. Each major wave in the 8-wave structure can be further divided into smaller waves based on different time spans...
In a bear market, the first 5 waves of the 8-wave structure are a downward trend, and the last 3 waves are a rebound trend. The impulse waves in a bear market are generally marked with uppercase letters A-E, and the correction waves are marked with numbers 1-3.
II. Characteristics of the 8-wave pattern (using a bull market as an example)
Wave 1 is the starting point of an upward trend and the beginning of a bull market.
Wave 2 moves downward, retracing a portion of the upward movement in wave 1. The retracement of wave 2 is usually at an important Fibonacci ratio, such as 61.8%.
Wave 3 surpasses wave 1, with expanding market volume and volatility. Generally, wave 3 contributes to the major upward movement of the entire bull market cycle. Wave 3 cannot be the shortest wave in the impulse wave.
Wave 4 is similar to wave 2, representing a partial retracement of wave 3. The typical retracement of wave 4 is 38.2%, which is also an important Fibonacci ratio.
Wave 5 is the last driving wave of a bull market, and its importance is generally not as great as wave 3. However, in the case of extreme market sentiment, wave 5 may further expand, even longer than wave 3. After wave 5 ends, the market will enter a period of adjustment.
Wave a is the first downward trend in the adjustment phase.
Wave b is an upward trend. Wave b may release false bullish signals, so it is often called a "bull trap".
Wave c is the last wave of adjustment, and its downward depth cannot be lower than the starting point of wave 1 (the beginning of the bull market).
3. How to use wave theory?
Wave theory has three major analysis elements: form, ratio, and time.
These three elements help investors better use wave theory to analyze market trends and perform "numerical wave" operations.
Form refers to a complete market cycle consisting of 8 waves: 5 driving waves and 3 adjustment waves. The 8-wave structure cycles to drive market operation. This is the foundation of wave theory and is of primary importance.
Waves have the "subdivision" attribute. Each big wave in 8 waves, if in line with the market trend, can be subdivided into 5 small waves; if against the market trend, it can be subdivided into 3 small waves.
Ratio refers to the special ratio relationship between waves in terms of price fluctuations, reflecting a certain degree of harmonious market trend.
The most widely used ratio here is the Fibonacci ratio. Taking the bull market as an example, the Fibonacci ratio can be reflected in the following aspects:
For wave 2 relative to wave 1, the common retracement level is 50% or 61.8%.
For wave 3 relative to wave 1, the price climb height is usually at a multiple relationship of 161.8% or 261.8%.
For wave 4 relative to wave 3, the common retracement level is 23.6% or 38.2%.
Time refers to the duration of each wave's operation, which can be used to support the analysis of form and ratio, but its importance is relatively secondary. For example, using the daily chart, investors can use a certain price reversal point as the reference date, predict the potential time points for future market tops or bottoms based on Fibonacci numbers, such as the 13th day, 21st day, or 34th day...
IV. Advantages and disadvantages of wave theory
Advantages:
The wave theory provides an important theoretical framework for analyzing market trends and patterns.
The wave theory has been widely used in the financial market. Although it has a long history, various wave patterns can still be found on candlestick charts today.
The wave theory helps investors understand the cyclical patterns in the market and predict potential market trends in the future.
Disadvantages:
The wave theory is highly subjective, and different people may analyze wave patterns in different ways, with no standard answer. Therefore, it is often criticized as "a thousand people, a thousand waves".
The wave theory is relatively complex and requires considering many different rules and scenarios.
The difficulty of "numbered waves" is high and quite time-consuming.
This content discusses technical analysis. Other methods, including fundamental analysis, may provide different perspectives. The examples provided are for illustrative purposes only and do not reflect expected results.
All investment involves risk, including the potential loss of principal, and no investment strategy can guarantee success.
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