What is Elliott Wave Theory?
Elliott Wave Theory, developed by Ralph Nelson Elliott in the 1930s, proposes that financial markets move in predictable, repetitive patterns called "waves." These patterns reflect the collective psychology of market participants — shifting between optimism, euphoria, fear, and panic in a natural cycle.
The core idea is that markets don't move randomly. Instead, they unfold in a specific 5-wave impulse pattern (with the trend) followed by a 3-wave corrective pattern (against the trend). This 5-3 pattern repeats at every degree of trend — from 1-minute charts to multi-decade cycles.
Patterns repeat at every timeframe — waves contain sub-waves
Waves reflect shifting crowd emotions and sentiment
Wave relationships follow Fibonacci ratios precisely
Predicts where price is likely heading next
The 5-3 Wave Structure
Every complete Elliott Wave cycle consists of 8 waves: 5 impulse waves followed by 3 corrective waves. The impulse phase moves in the direction of the larger trend, while the corrective phase partially retraces it.
Impulse Phase (5 Waves)
The initial move. Few recognize the new trend. Smart money starts accumulating. Usually the weakest impulse wave.
Emotion: DisbeliefRetraces most of Wave 1 (typically 50-61.8%). Traders think the old trend is resuming. Volume decreases.
Emotion: Fear (false alarm)The strongest and longest wave. The trend is now obvious, volume surges, and the crowd piles in. Often extends to 1.618× Wave 1.
Emotion: Confidence → EuphoriaA complex, sideways correction. Shallower than Wave 2 (typically 23.6-38.2% of Wave 3). Volume dries up.
Emotion: ImpatienceThe last impulse wave. Often weaker than Wave 3 with declining momentum (divergence on RSI/MACD). The "blow-off top."
Emotion: Greed → ManiaCorrective Phase (3 Waves)
The first leg down. Most think it's just a pullback in the uptrend. Smart money exits.
Emotion: DenialA counter-trend rally that lures traders back in. Often called a "bull trap" — reaches near old highs but fails.
Emotion: False hopeThe final sell-off. Often equals Wave A in length. Panic selling, capitulation volume. Marks the end of the correction.
Emotion: Panic → DespairElliott Wave Pattern Visualized
The chart below shows the complete 5-3 Elliott Wave cycle — five impulse waves (green) driving the trend upward, followed by three corrective waves (red) partially retracing the move. Each wave point is labeled so you can see the structure in action.
Elliott Wave Rules & Guidelines
Elliott Wave has three inviolable rules and several guidelines. If any rule is broken, your wave count is wrong. Rules are absolute; guidelines are "most of the time."
Wave 2 Cannot Retrace Beyond Wave 1's Start
Wave 2 can retrace up to 99.99% of Wave 1, but it can never go below the start of Wave 1. If it does, your count is wrong.
Wave 3 Cannot Be the Shortest Impulse Wave
Wave 3 doesn't have to be the longest (Wave 5 sometimes extends), but it can never be shorter than both Wave 1 and Wave 5.
Wave 4 Cannot Enter Wave 1's Territory
The low of Wave 4 cannot overlap with the high of Wave 1 (except in diagonal triangles). This keeps the impulse structure clean.
Wave 2 and Wave 4 tend to alternate in form — if Wave 2 is sharp, Wave 4 is typically flat, and vice versa.
Wave 3 typically has the highest volume of all impulse waves. Volume should increase in the direction of the trend.
Two of the three impulse waves (1, 3, 5) tend to be equal in length. Most often, Wave 1 = Wave 5.
Impulse waves tend to travel within a channel. Draw a line through Wave 2 and Wave 4 endpoints for the channel bottom.
Fibonacci & Elliott Wave Connection
Fibonacci ratios are integral to Elliott Wave analysis. Each wave has typical Fibonacci relationships to other waves, which helps predict targets and validate wave counts.
Practical Wave Counting Tips
1. Start on Higher Timeframes
Count waves on the weekly/daily chart first. Once you identify the higher-degree structure, zoom into 4H/1H to refine sub-waves. Higher timeframes give clearer patterns.
2. Look for Wave 3 First
Wave 3 is the most obvious — it's the longest, strongest move with the highest volume. Find Wave 3, then work backward to identify Waves 1-2 and forward for 4-5.
3. Use Multiple Indicators
RSI/MACD divergence at Wave 5 is a classic confirmation. Volume should peak at Wave 3 and decline into Wave 5. Use Fibonacci to measure wave relationships.
4. Have Multiple Counts Ready
Professional Elliott Wave analysts always maintain multiple valid wave counts (primary, alternate). If price action invalidates your primary, switch to the alternate instantly.
5. Don't Force the Count
If you can't clearly see a wave pattern, don't force one. Elliott Wave works best in clearly trending markets. Choppy, range-bound markets produce unreliable counts.
Frequently Asked Questions
Is Elliott Wave Theory reliable?
Elliott Wave provides a useful framework for understanding market structure, but it is subjective. Different analysts can produce different wave counts from the same chart. It works best when combined with other analysis tools like Fibonacci, RSI, and volume. Used alone, it can lead to confirmation bias. Used within a system, it adds valuable context.
Which wave is the best to trade?
Wave 3 is the most profitable wave to trade because it is the strongest, longest, and most clearly directional. The ideal entry is at the end of Wave 2 (a Fibonacci retracement of Wave 1). Wave 5 can also be traded, but with caution since it often ends with momentum divergence.
How does Elliott Wave relate to Fibonacci?
Fibonacci ratios define the relationships between waves. Wave 2 typically retraces 50-61.8% of Wave 1, Wave 3 often extends to 1.618× Wave 1, and Wave 4 usually retraces 23.6-38.2% of Wave 3. These Fibonacci relationships help validate wave counts and set price targets.
Does Elliott Wave work for crypto?
Yes, Elliott Wave patterns appear in crypto markets, but crypto's extreme volatility and 24/7 trading can make wave counting more challenging. Impulse waves (especially Wave 3) tend to be more extended in crypto. Use higher timeframes (Daily, Weekly) for clearer patterns and always pair with risk management.
What is the difference between impulse and corrective waves?
Impulse waves (1-2-3-4-5) move in the direction of the larger trend and consist of 5 sub-waves. Corrective waves (A-B-C) move against the trend and consist of 3 sub-waves. Impulse waves are typically stronger with higher volume, while corrective waves are weaker and more complex.
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