Technical Analysis
Elliott Wave Theory: The Market Moves in Predictable Waves
Ralph Elliott discovered that markets trend in five-wave impulses and correct in three-wave structures — a fractal pattern that repeats on every timeframe.
Key rules
- Five waves in the direction of the trend (impulse), three waves against (correction — ABC)
- Wave 3 is never the shortest impulse wave — if it is, your count is wrong
- Wave 2 cannot exceed 100% retracement of Wave 1 — if it does, reassign Wave 1
- Use Fibonacci to project wave targets: Wave 3 often extends to 161.8% of Wave 1
- Focus on high-probability zones (Wave 3 entry, Wave 5 exit) rather than trying to predict the entire count
Ralph Nelson Elliott published his wave theory in 1938, proposing that crowd psychology (and therefore markets) moves in recognisable, repetitive patterns — waves. Elliott Wave Theory is fractal: the same five-three wave structure appears on a 1-minute chart as on a monthly chart.
**The Five-Wave Impulse** In a bull market, price advances in five waves: - **Wave 1**: First advance — few recognise the trend change - **Wave 2**: Retracement of Wave 1, typically 50–61.8% — creates doubt - **Wave 3**: The strongest and most extended wave — most traders enter here - **Wave 4**: Another retracement — shallower than Wave 2, often 23.6–38.2% of Wave 3 - **Wave 5**: Final push higher, often with weakening momentum (divergence)
Waves 1, 3, and 5 are impulse waves (with the trend). Waves 2 and 4 are corrective.
**The Three-Wave Correction (ABC)** After the five-wave impulse completes, price corrects in three waves: A (initial decline), B (false recovery/retracement of A), C (continuation of correction, often to the same depth as A). The ABC correction ends the full cycle.
**Key Rules (Never Violated)** - Wave 2 cannot retrace more than 100% of Wave 1 - Wave 3 is never the shortest impulse wave (often the longest) - Wave 4 cannot overlap with Wave 1's price range (in non-leveraged cash markets)
**Fibonacci Relationships** Wave 2 typically retraces 50–61.8% of Wave 1. Wave 3 is often 161.8% of Wave 1. Wave 4 retraces 23.6–38.2% of Wave 3. Wave 5 is often equal to Wave 1. These relationships make Fibonacci a natural complement to Elliott Wave.
**Practical Challenges** Elliott Wave is notoriously subjective — different analysts label the same chart differently. The most practical application: use it to identify the likely position within a trend (are we in a Wave 3 impulse or a Wave 5 exhaustion?) rather than rigid count tracking.