Boy is it hard to make sense of the Forex market when you first see it. The term volatility doesn't do it justice. It can be very daunting to jump into the Forex market without any idea of what you're doing, and try to make sense of what you're looking at. Smarter people than me though have discovered ways to see patterns in the market. One such method for this is known as the Elliot Wave principle.

WHAT ELLIOT WAVES ARE

Elliot Waves are waves of price fluctuations on a financial market that follow a specific pattern, which I'll tell you about in a minute. Elliot Wave theory says that the moods of people change in predictable ways. Trends move in specific directions, gaining momentum as more investors move in the direction of the trend, and changing direction on a large scale as people tend to jump on to trends as they happen. Elliot Waves are a way of analyzing those patterns in any time frame and predicting the way the market will move.

WHO DISCOVERED THEM?

An account named Ralph Nelson Elliot formulated the Elliot Wave theory in a 1938 book called The Wave Principle. He was able to use his theory originally to make predictions for the behaviour of stock markets, but it turned out that the Elliot Wave principle actually applied to anything involving the psychology of large groups of people. If you analyze the behaviour of people doing anything at all, even clothes shopping, you'll see Elliot Waves. And they're great for Forex, because there are so many people involved in it.

HOW DO ELLIOT WAVES WORK?

There's a couple of sorts of waves in the Elliot Wave principle - impulsive waves and corrective waves. Impulsive waves drive markets. Corrective waves, just like you would imagine, deliver corrections to those impulses. In order to fall within the Elliot Wave principle, there is a specific pattern to the way these impulsive and corrective waves behave. These patterns can be seen over any time frame, from minutes to centuries.

THE WAVES

There are five waves in the dominant trend and three waves in the corrective trend. They go up and then down in a bullish market, and down and then up in a bearish market. The first wave (Wave 1) is impulsive. The second wave (Wave 2) is corrective, but never to the point that it passes where Wave 1 started from. The third wave (Wave 3 is impulsive again, and usually the biggest wave. It moves well past where Wave 1 ended. The fourth wave (Wave 4) is again a corrective wave, but not does not overlap with Wave 1. The fifth wave (Wave 5) is the final part of the dominant trend. This is where the dominant trend stops and the corrective trend starts. The sixth wave (Wave A) is the first part of the corrective trend - a correction that starts the overall trend moving in the opposite direction. The seventh wave (Wave B) is the last impulsive wave, actually a correction of a correction, it's a temporary reversal. The eighth and final wave (Wave C), which is the final correction of the overall trend. It's usually even bigger than Wave A. Within each of these waves you'll find smaller waves that follow the same principle over a shorter time frame, and the waves are usually part of a bigger trend that also follows the same principle over a longer time frame. This is known as a fractal - where patterns are similar over all degrees.

WHAT CAN YOU DO WITH ELLIOT WAVES?

You can use Elliot Waves to help determine when to get into or out of a trend. This isn't ESP - they don't predict the future 100 per cent of the time. But they're an extremely useful tool in analyzing the way that the market moves.