Elliott Wave Theory

What Elliott Wave Theory means

Developed by Ralph Nelson Elliott in the 1930s, the theory holds that collective market psychology unfolds in repeating, self-similar patterns. A complete cycle consists of a five-wave impulse labelled one to five moving with the larger trend, followed by a three-wave correction labelled A, B and C moving against it. Waves one, three and five advance while two and four correct. Each wave subdivides into the same structure at a smaller degree, so the pattern is fractal and can be counted from minute charts up to multi-year moves.

Three rules are inviolable in a standard impulse: wave two never retraces beyond the origin of wave one, wave three is never the shortest of waves one, three and five, and wave four does not enter the price territory of wave one. Beyond these, guidelines about alternation and channelling help. Fibonacci ratios are used heavily to estimate wave targets, so retracement and extension tools are standard companions to a wave count.

The practical difficulty is that wave counts are interpretive. Two competent analysts can label the same chart differently, and counts are frequently revised as new price data arrives, which makes the method vulnerable to hindsight bias. Used honestly it is a way of organising structure and defining invalidation levels, since each rule provides a precise price at which a count is wrong. It is not a predictive engine, and it should never be treated as a source of certainty about future prices.