Ralph Nelson Elliott predicted a stock market bottom in 1935 through pattern analysis of price movements.

His research covered 75 years of market data across multiple indexes, leading to the development of Elliott Wave Theory rules for market forecasting.

Elliott Wave International, now the largest independent financial analysis firm, applies these pattern-based methods to predict market movements.

The theory maps specific price patterns: five waves moving with the main trend, followed by three corrective waves – each sequence reflecting shifts in market psychology.

This guide examines Elliott Wave Theory fundamentals, wave patterns, trading rules, and Fibonacci relationships.

Traders at every level will learn to spot these recurring market patterns and apply them effectively to their analysis methods.

Elliott Wave Theory Basics

Elliott Wave Theory maps market movements through repeating wave patterns.

The method stands apart from standard price analysis by focusing on market psychology patterns.

Elliott Wave Origins

Psychology in Wave Patterns

Elliott Wave Theory shows how crowd psychology moves markets. 

Mass sentiment shifts between optimism and pessimism create measurable wave sequences. 

These mood changes form price patterns across all timeframes.

Price moves up when optimism dominates and down during pessimistic periods. 

Market reactions to news often appear random – the same announcement might spark buying one day but selling the next.

This happens because crowd psychology, not external events, primarily drives prices.

Elliott found investor sentiment follows set paths from market bottoms to tops.

His wave patterns track these psychological shifts that repeat regardless of news events.

Fractal Pattern Structure

The theory’s core strength lies in its fractal nature. 

Market patterns mirror themselves across timeframes, like nested shapes repeating at different scales.

Key pattern elements:

• Five waves in the main trend direction (impulse waves)
• Three waves moving against the trend (corrective waves)
• Each wave contains smaller versions of these patterns

Elliott classified nine wave degrees from Grand Supercycle to Sub-minuette. 

This structure helps traders locate current market position.

The fractal concept proves valuable when viewing multiple timeframes. 

A corrective wave on yearly charts might contain developing impulse waves in shorter timeframes.

This layered view reveals potential price moves across different scales.

Wave Pattern Structure

Elliott Wave Theory centers on a 5-3 wave sequence that repeats across markets.

This pattern serves as the primary tool for market position analysis.

Five-Wave Impulse Patterns

Motive waves follow the main trend direction, splitting into five smaller waves. 

Three waves (1, 3, 5) push prices forward while waves 2 and 4 create brief pullbacks.

Key rules for impulse waves:

• Wave 2 stops before erasing Wave 1
• Wave 3 must exceed Waves 1 or 5 in length
• Wave 4 cannot reach Wave 1’s price zone

Diagonal waves form another motive pattern type. 

These create wedge shapes while keeping the five-wave structure.

Three-Wave Corrections

Corrective waves move against larger trends in three parts: A, B, and C. 

These patterns show more complexity than motive waves, often revealing their full structure only after completion.

Main correction types:

• Zigzags: Sharp 5-3-5 moves against trend
• Flats: Sideways 3-3-5 movements
• Triangles: Five 3-3-3-3-3 waves forming wedges

Markets sometimes display complex corrections, combining multiple basic patterns. 

Remember: corrections never show five-wave structures – that pattern belongs solely to motive waves.

Time Scale Hierarchy

Wave patterns nest across nine distinct degrees:

• Grand Supercycle: Spans centuries
• Supercycle: 40-70 year periods
• Cycle: Multi-year trends
• Primary: 2-year maximum
• Intermediate: Several months
• Minor: Weekly patterns
• Minute: Daily moves
• Minuette: Hourly changes
• Subminuette: Minute-by-minute

This structure creates self-contained patterns. 

Each complete five-wave sequence becomes one piece of a larger degree pattern.

Traders use these relationships to spot potential market turns across multiple timeframes.

Core Rules for Impulse Waves

Three strict rules determine valid impulse waves in Elliott Wave analysis.

These rules form the foundation for accurate wave pattern identification.

Wave 2 Rule: Price Limits

Wave 2 must stop before reaching Wave 1’s starting point .

Most Wave 2 moves retrace 38% to 78% of Wave 1, with 61.8% marking the most frequent reversal zone .

Retracements beyond 78% signal potential pattern problems .

Traders watch this rule closely since it validates the trend’s direction.

Pattern identification requires complete restart if Wave 2 breaks Wave 1’s origin point .

Wave 3 Rule: Length Requirements

Wave 3 cannot be the shortest impulse wave.

This wave typically shows the strongest momentum and highest trading volume.

Wave 3 often extends to 161% or 261% of Wave 1’s length .

Key Wave 3 traits:

• Must exceed Wave 1 or 5 in length
• Shows strongest price momentum
• Requires impulse structure
• Cannot form diagonal patterns

Wave 4 Rule: Price Territory

Wave 4 must avoid Wave 1’s price zone .

This rule maintains the trend’s structure. Most Wave 4 moves retrace 23% to 38.2% of Wave 3 .

Strong trends might show only 14% retracement .

One technical note: Elliott used closing prices for analysis.

Modern traders might accept minor candlestick wick overlaps while rejecting clear price zone violations .

Wave 5 Patterns

Wave 5 shows specific traits though not strict rules.

Price often reaches Wave 1’s length or 61.8% of Wave 1 .

Key signs of Wave 5 completion:

• Momentum indicators diverge from price
• Volume drops below Wave 3 levels
• RSI shows lower highs despite price peaks

These characteristics help traders spot pattern endings and prepare for corrective phases.

Corrective Wave Patterns

Markets pause through corrective waves, showing three distinct pattern types.

Each pattern carries unique traits for market analysis.

Zigzag Structure: 5-3-5 Pattern

Zigzags cut sharp paths against main trends.

Their A-B-C sequence follows strict rules:

• Wave A: Forms five-wave impulse
• Wave B: Creates partial retracement
• Wave C: Completes with five waves past Wave A’s end

Second waves often show zigzags while fourth waves rarely do. Strong trends might stack multiple zigzags with X-waves between them.

Flat Formation: 3-3-5 Pattern

Flat patterns move sideways with weaker Wave A structure than zigzags.

Three flat types show different endpoints:

Regular Flats: Wave B stops near Wave A’s start Expanded Flats: Both B and C waves pass their typical endpoints Running Flats: Wave B extends but C falls short

These patterns signal strong trends, appearing near impulse wave extensions.

Triangle Types: 3-3-3-3-3 Pattern

Triangles show five three-wave parts labeled A through E.

Four key shapes:

• Contracting: Waves shrink
• Barrier: One side stays flat
• Expanding: Waves grow larger
• Running: Wave B sets new extreme

Triangle patterns only emerge before the trend’s final wave.

Complex Corrections

Markets sometimes link basic patterns with X-waves:

• Double Threes: Two patterns (W-X-Y)
• Triple Threes: Three patterns (W-X-Y-X-Z)

These combinations create longer sideways moves while markets resolve uncertainty before trend resumption.

Fibonacci Numbers in Wave Analysis

Fibonacci ratios provide precise measurement tools for Elliott Wave patterns.

The sequence (1, 1, 2, 3, 5, 8, 13, 21, 34…) creates key ratios found throughout market movements.

Core Fibonacci Ratios

Three primary ratios guide wave measurements:

• 0.618 (Golden Ratio)
• 0.382
• 1.618 (Golden Ratio inverse)

These numbers emerge from sequence divisions. 

Example: 13÷21 yields 0.618, while 13÷34 produces 0.382.

Elliott found these ratios repeat across all market timeframes.

Traders use them to validate patterns and project price targets.

Wave 2 and 4 Retracements

Wave 2 typical retracement zones:

• 50% to 85.4% of Wave 1
• Most common: 61.8% level
• Warning sign: Above 78.6%

Wave 4 common pullbacks:

• 14.6% of Wave 3
• 23.6% of Wave 3
• 38.2% of Wave 3

Wave 4 shows smaller retracements than Wave 2. 

Moves beyond 50% suggest pattern problems.

Wave 3 and 5 Extensions

Wave 3 typical extensions:

• 161.8% of Wave 1
• 261.8% of Wave 1
• 323.6% of Wave 1

Wave 5 common targets:

• Equal to Wave 1
• 61.8% of Wave 1
• 61.8% of Waves 1+3 combined
• Extended: 161.8% of Waves 1-3

Traders combine these ratios with RSI, MACD, and trend lines for precise entry and exit points.

Elliott Wave Theory Rules Summary

Elliott Wave patterns reveal market movements through crowd behavior and wave sequences.

This guide shows pattern applications across market conditions and timeframes.

Three strict impulse wave rules plus corrective pattern guidelines give traders clear markers for market turns.

These foundational rules point to high-probability trade setups.

Fibonacci ratios bring mathematical structure to wave analysis.

Key numbers like 0.618 and 1.618 help pinpoint potential market reversals with precision.

The theory’s core strength lies in pattern consistency.

Markets follow predictable sequences despite external events.

Wave structures repeat across all timeframes, creating reliable technical signals.

Wave analysis offers traders:

• Clear pattern identification rules
• Precise measurement tools
• Crowd psychology insights
• Risk management framework

These elements combine to form a structured method for finding trade opportunities in any market condition.

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