Understanding Wave Analysis

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While it may sound like something a marine scientist would do, wave analysis is one of the most basic and therefore most important aspects of forex. So whether you are a novice or a seasoned trader, you will find yourself referring to wave analysis in making trade decisions.

But first, let’s talk about what wave analysis is. Based on the Elliott wave theory, it represents price movements of currencies on a chart in the form of a wave. If you are familiar with how stock prices are depicted in trading sites or in the news (that is, a line graph zig-zagging across the chart), then you already have an idea about what we are talking about.

Let’s go deeper. More than just figures, wave analysis looks into investor psychology for clues on what is going to happen next in the forex market. The clues may be seen in patterns, and the usual pattern is that the price of a currency will usually move in 5 waves towards the direction of a larger trend, and that there will be three waves to correct the movements.

When looking a wave, separate them into minor, intermediate and major waves. The minor one happens in your 15-minute charts where there can be frenetic movement as people buy and sell currency. The hourly charts, meanwhile, are in the realm of intermediate waves, and the major waves determine the movement of the currency as seen on a daily chart. So if a minor wave goes on an upward trend, then the intermediate wave will go up. The same can be said of the relationship between the intermediate and major waves.

Now how do you use these waves to your advantage? If you follow intermediate waves, for example, use previous daily charts to see the direction the currency would take on that day, while using minor waves to determine when you should enter into trade and exit it.

By FX Strategy Team, Published on 14th of March 2013
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