One of the key factors, which has influence on any trader’s success is his ability to correctly predict the market movements. The two main methods are technical and fundamental analysis of forex market. Wave analysis is a method of technical analysis based on the Elliott Wave Theory. Today this is the most popular way of forecasting the situation on forex either among novice traders or professionals. Moreover, the wave analysis is considered as fundamental for technical analysis of the currency market.
Back in 1934, Ralph Nelson Elliott discovered that price action displayed on charts, instead of behaving in a somewhat chaotic manner, had actually an intrinsic narrative attached. Elliot saw the same patterns formed in repetitive cycles. These cycles were reflecting the predominant emotions of investors and traders in upward and downward swings. These movements were divided into what he called "waves". Elliott adopts the 3 impulses and 2 corrections of the Dow Theory, but achieves a higher precision.
According to the Elliot wave theory, the price movements of any currency can be depicted on the chart in the form of waves. Waves are subdivided into three impulse waves, directed towards the main trend, and two corrective waves directed against the trend. These waves are marked with numbers 1, 2, 3, 4, 5. When the active development of the trend is over, begins the correction of the price movement which is depicted with three waves on the chart. Two of these waves are motive, one of them is a corrective. These waves are marked as A, B and C.
In addition, the theory holds that each of the counter trend waves – i.e., wave number 2 and number 4 – will unfold in an ABC pattern. In other words, during waves 2 and 4 of a five-wave uptrend, the security in question will retrace part of the wave 1 advance in a pattern consisting of two smaller down waves (labeled A and C) separated by one up wave (labeled B). Likewise, during waves 2 and 4 of a five-wave down-trend, the security in question will retrace part of the wave one decline in a pattern consisting of two smaller up-waves (labeled A and C) separated by one down-wave (labeled B).
Wave analysis is quite powerful instrument which helps to make good profit by working on the forex market. The main disadvantage of the theory is that you need to spend a lot of time getting invaluable experience and adjusting the common trading strategy for yourself in order to apply it in real trading successfully and to make a decent profit. To achieve the best results from using the Elliott wave analysis in your forex trading you should always combine this method with the other technical analysis tools.