Understanding Elliott Wave

Before traders get to grips with the basic facets of Elliott Wave Analysis, they need to become familiar with the four cornerstones of technical analysis as a methodology. Think of them as golden rules which need to be considered true at all times. You see, technical analysis has been developed and refined throughout the late 19th and 20th century, based upon market behaviour and patterns. It’s a historical methodology, one which present day traders still use to make significant trading decisions.

So, before we explore technical analysis any further, make a note of these four cornerstones and keep it in an obvious place at your trading station. Be sure to keep referencing back to it as you make trading decisions based upon technical analysis.

The four cornerstones of technical analysis

Cornerstone #1: currency price incorporates all available market information

Advocates of technical analysis sometimes criticise fundamental analysis because it’s difficult to quantify market sentiment and unexpected economic news events. Technical analysis removes this problem, as it considers currency price to incorporate ‘certain’ market information. This market information tends to centre around economic forecasts, central bank data, and interest rate changes. It means that current currency pair price should be thought of as being absolutely accurate. 

Cornerstone #2: price movements are never random

Consensus amongst technical analysts is that currency prices move in trends, interweaving with briefer periods when price fluctuations are random. The job of a Forex trader utilising technical analysis is to be able to distinguish between those periods, before placing trades to exploit currency price trends.

Cornerstone #3: what’s happened before, will happen again

The financial markets are renowned for a phenomenon known as ‘herd mentality’. Let’s consider the Forex industry in isolation. There are thousands upon thousands of retail traders who all have the same objective: to make profits by trading currency. This shared mentality means that as a collective, Forex traders tend to react to particular situations in a similar fashion. Technical analysts have enough historical data to predict how the market as a whole will react psychologically to economic news events. This means that technical analysts are in a position to predict future market reactions should those circumstances arise again.

Cornerstone #4: focus on the what, not the why

To become proficient at technical analysis, traders must shift their focus away from pinpointing why currency price has moved. Instead, they need identify what the current currency price is, before identifying its price movement history. Taking this approach removes the facets of fundamental analysis that try to quantify market sentiment and unpredictable economy news events. By doing so, traders are able to focus on information and economic data that directly affects currency price.