Elliott wave theory: How does investors’ sentiment impact stock prices?

# Elliott wave theory: How does investors’ sentiment impact stock prices?

Updated: 22 Jul 2022, 10:07 AM IST
TL;DR.

## The Elliott Wave theory is a type of technical analysis that searches for recurring long-term price patterns connected to enduring shifts in investor's sentiment. Continue reading as we discuss the types of waves in this theory.

The Elliott wave theory is a type of analysis tool that aids traders in understanding the cycles of the financial markets.

American novelist and accountant Ralph Nelson Elliott created the Elliott wave theory as a technical analysis method in the 1930s. Since then, the theory has evolved into a trustworthy resource for many different portfolio managers throughout the globe.

The elliott wave theory is a type of analysis tool that aids traders in understanding the cycles of the financial markets. According to this, market movements are said to be influenced by a series of cycles in crowd psychology. Using this theory, traders may predict market patterns by spotting price and investor psychological extremes.

## Types of waves in elliott wave theory

There are two main types of waves- motive waves and corrective waves.

### Motive waves

Motive waves are composed of five waves that are referred to as Waves 1, Wave 2, Wave 3, Wave 4, and Wave 5. They flow in the direction of the primary trend whereas Waves 2 and 4 go in the opposite direction. Impulse and diagonal waves are the two main categories of motive waves.

However, It was found that a motive wave might consist of three waves rather than five in real-time markets. In reality, the market will often experience a motive wave made up of three waves. The market might possibly continue to move in corrective waves. Three-wave trends are therefore more typical than five-wave trends.

### Corrective waves

Corrective waves are those that run contrary to the primary trend and are made up of three waves namely A, B and C. Compared to motive waves, corrective waves are more intricate and time-consuming. Triangle Waves, Zig-Zag Waves, and Diagonal Waves are the three primary forms of corrective waves.

As observed, a motive wave drives the stock price up in a bull market, whereas a corrective wave changes the tendency. In contrast, a corrective wave will increase the stock price during a bearish market while a motive wave will decrease it.

## Tools used to evaluate the elliott waves

### Fibonacci retracement

Fibonacci retracement as used in Elliott Wave Theory, is the process of identifying the point at which a correction finishes to allow the main trend to resume. They gauge how far a trend's pullbacks go.

### Fibonacci extensions

Fibonacci extensions are another often utilised technique. Fibonacci extensions are used to pinpoint a key trend's turning points. They show the potential path of a motive wave prior to a downturn in a bull market. They may be used to identify support levels during a down market.

Elliott wave enthusiasts emphasise that just because a market is fractal does not automatically make it simple to anticipate. One of the main flaws is that practitioners may always point the finger to their interpretation of the charts rather than flaws in the theory. If not, the duration of a wave might be interpreted in an ambiguous manner.

It does, however, give a substantial amount of clarity to the art of trend spotting. Elliott's original principles may be made as complicated as a trader wants, but it is unquestionably an approach that many traders choose to prioritise in their market tactics.

First Published: 22 Jul 2022, 10:07 AM IST