# A prediction tool: The basics of Elliott's wave theory

by , 22 January 2014

Some traders swear by Elliott's wave theory. But one this is for sure when it comes to this technical analysis tool - it is complex. There are reams written on it and how to use it and interpret it. But if you want to learn more about it, read on to uncover some of the starting points you need to know about…

When it comes to using and interpreting Elliott wave theory, there are a number of key rules that you have to apply, Max Munroe in Forex Round-Up explains…

There are two different kinds of waves: Impulse waves and corrective waves. And there are a few rules you must stick to. You can read more about these here.

When using Elliott wave another key aspect to note is the fractal nature of the wave. This means that smaller wave cycles can make up each wave cycle, all adhering to the same Elliott wave principles.

The whole thing can also itself make up waves within an even larger cycle and so on and so on.

It is also possible for some waves to be broken up into further three or five wave combinations. However outlining the various combinations is something more complex we won’t go into here.

Making predictions based on Elliott wave

So if you apply these principles to a real chart, you are able to make some basic predictions based on Elliott wave counting to suggest future market behaviour:.

Here it is not yet clear if the A wave is correct (having been broken into a three wave count) or if A should be C having completed the cycle. You will have to see how it turns out.

When making trading decisions based on Elliott Wave, it soon becomes clear which waves you should pay the most attention to. Since wave 3 is usually the largest wave in the cycle, entering a new trend on the first retracement is often the most advantageous trade and statistically most likely to give a good risk reward.

Likewise, trying to enter into the same trade for a wave five continuation, you will most likely reduce the risk/reward and the entry less accurate, increasing the risk further. It is also very helpful to know when a wave five has completed so that you can take profit before the correction.

This just touches the surface of Elliott Wave. However it can be a very effective method of predicting market behaviour once you master the finer points of the technique.