How Can I Apply the Elliott Wave Principle?

How Can I Begin Applying the Elliott Wave Principle?

When investors first discover the Elliott Wave Principle, they’re often most impressed by its
ability to predict where a market will head next.

And it is impressive. But its real power doesn’t end there. The Elliott Wave Principle also gives
you a method for identifying at what points a market is most likely to turn. And that, in turn,
gives you guidance as to where you might enter and exit positions for the highest probability of
success.

So, how do you begin applying the Elliott Wave Principle? By starting at its most basic level.
The Elliott Wave Principle works by identifying patterns in market prices. So, in other words, we
start by analyzing waves on a chart.

Elliott’s pattern consists of “impulsive waves” and “corrective waves.” An impulsive wave is
composed of five subwaves. It moves in the same direction as the trend of the next larger size. A
corrective wave is divided into three subwaves. It moves against the trend of the next larger size.

As the figure below shows, these basic patterns build to form five and three-wave structures of
increasingly larger size (larger “degree,” as Elliott said).

In the above illustration, waves 1, 2, 3, 4 and 5 together complete a larger impulsive sequence,
labeled wave (1). The impulsive structure of wave (1) tells us that the movement at the next
larger degree of trend is also upward. It also warns us to expect a three-wave correction — in this
case, a downtrend.
That correction, wave (2), is followed by waves (3), (4) and (5) to complete an impulsive
sequence of the next larger degree, labeled as wave 1. At that point, again, a three-wave
correction of the same degree occurs, labeled as wave 2.

So, in applying the Elliott Wave Principle, our first task is to look at charts of market action and
identify any completed five-wave and three-wave structures. Only then can we interpret where
the market is and where it’s likely to go.

But while applying the Elliott Wave Principle to any chart, we must keep in mind an important
point. The Elliott Wave Principle does not provide certainty about any one market outcome.
Instead, it gives you an objective means of determining the probability of a future direction for
the market. At any time, two or more valid wave interpretations usually exist. So, it’s important
for any investor or trader to carefully assess the probability of each interpretation.

View the Elliott Wave Principle as your road map to the market and your investment idea as a
trip. We start the trip with a specific plan in mind, but conditions along the way may force us to
alter our course. “Alternate counts” are simply side roads that sometimes end up being the best
path.

Elliott’s highly specific rules keep the number of valid interpretations (or “alternate counts”) to a
minimum. The analyst usually considers as “preferred” the one that satisfies the largest number
of guidelines. The top “alternate” is the one that satisfies the next largest number of guidelines,
and so on. Alternates are an essential part of using the Elliott Wave Principle.

Another key to applying the Elliott Wave Principle is Fibonacci ratios. Few investors realize that
Fibonacci analysis of the markets was pioneered by R.N. Elliott. The use of Fibonacci ratios
requires a valid Elliott wave interpretation as a starting point. Elliott had two chief insights
concerning Fibonacci relationships within waves. First, corrective waves tend to retrace prior
impulse waves of the same degree in Fibonacci proportion — common wave relationships
include 38%, 50% and 62%. Second, impulse waves of the same degree within a larger impulse
sequence tend to relate to one another in Fibonacci proportion.
Wave interpretation rules and Fibonacci relationships together are powerful tools for establishing
investment strategies and reducing risk exposure. Applying the Elliott Wave Principle aids
investors in deciding where to get in, where to get out and at what point to give up on a strategy.
Thus, the Elliott Wave Principle lets you identify the highest probability direction for the market.

The basics of the Wave Principle remain as Elliott formulated them. Those basics are fully
described in the standard textbook of wave analysis, Elliott Wave Principle — Key to Market
Behavior, by A.J. Frost and Robert R. Prechter, Jr. (Prechter is founder and president of Elliott
Wave International.) That book rescued the Elliott Wave Principle from obscurity and propelled
it to worldwide acceptance as perhaps the most sophisticated form of technical analysis.
Remember — applying the Elliott Wave Principle is simple, but mastering that application takes
years of practice and hard work. Yet, it is worth it to take the time and learn how to make proper
counts. There are several Elliott wave software applications out there that claim to do all the best
wave counts for you, but with all the variables in the market, it is much better to make the counts
yourself.

What is an Elliott wave and What Does it Look Like?

Elliott waves are the basic building block of the Wave Principle.

The Wave Principle is Ralph Nelson Elliott’s discovery that social, or crowd, behavior trends
and reverses in recognizable patterns. Elliott discovered that the ever-changing path of stock
market prices reveals a structural design that in turn reflects a basic harmony found in nature.
From this discovery, he developed a rational system of market analysis. Elliott isolated 13
patterns of movement, or “waves,” that recur in market price data and are repetitive in form but
not necessarily repetitive in time or amplitude. He named, defined and illustrated the patterns.
These patterns are Elliott waves.

These Elliott waves link together to form larger versions of those same patterns. They, in turn,
link to form identical patterns of the next larger size, and so on. The result is the illustration you
see below:
In markets, progress ultimately takes the form of five Elliott waves of a specific structure. As
you can see below in the most basic Elliott wave structure, waves (1), (3) and (5) actually affect
the directional movement. Waves (2) and (4) are countertrend interruptions.

The two interruptions are a requisite for overall directional movement to occur. And though there
are several variations of Elliott waves, all of them fit into the basic structure you see above. The
stock market is always somewhere in the basic five-wave pattern at the largest degree of trend.
Because the five-wave pattern is the overriding form of market progress, all other patterns are
subsumed by it.

How Does Elliott Wave Analysis Work?

Elliott wave analysis is based upon the Elliott Wave Principle, which states that investor
psychology is the real engine behind the stock markets.

Robert Prechter, Elliott Wave International’s founder and president, explains:

“The Wave Principle is a catalog of the ways that the crowd goes from the extreme point of
pessimism at the bottom to the extreme point of optimism at the top. It is a description of the
steps human beings go through when they are part of the investment crowd, in order to change
their psychological orientation from bullish to bearish. Since people don’t change much, the path
they follow in moving from extreme pessimism to extreme optimism and back again tends to be
the same over and over, regardless of news and extraneous events.”

Therefore, Elliott wave analysis involves deciphering the psychological orientation of the
investment crowd through the wave patterns evolving in various stock markets. And since we
here at Elliott Wave International use Elliott wave analysis on all of the world’s major stock
indexes, we’re confident we can gauge how investor psychology is trending.

In order to utilize Elliott wave analysis, you must become familiar with the Elliott Wave
Principle. The Elliott Wave Principle enables you to properly decipher the wave patterns
unfolding in each stock market and then make predictions on which wave patterns are most
likely to occur next — this is the basis of Elliott wave analysis.

Each Elliott wave structure carries with it unique personality traits and is followed by another
specific and unique structure. Studying these patterns eventually allows analysts to be able to
predict both what may occur next, and — possibly even more importantly — what won’t happen
next.

Elliott wave analysis requires patience and diligence, but it is very simple to employ.

What is Technical Analysis? How is it different from Fundamental Analysis?

Technical analysis is a method of evaluating stock prices by relying on market data, such as
charts of price and volume, to help predict future market trends. Investors who rely on technical
analysts strive to accurately predict the future price of a stock by looking at its historical prices
and other trading variables.

Technical analysis hinges on the belief that psychology influences trading in a way that enables
predicting when a stock will rise or fall.

Bob Prechter, Elliott Wave International’s founder and president, has called the Elliott Wave
Principle “the purest form of technical analysis.” He explains, “The Wave Principle is a catalog
of the ways that the crowd goes from the extreme point of pessimism at the bottom to the
extreme point of optimism at the top. It is a description of the steps human beings go through
when they are part of the investment crowd, to change their psychological orientation from
bullish to bearish. Since people don’t change much, the path they follow in moving from extreme
pessimism to extreme optimism and back again tends to be the same over and over, regardless of
news and extraneous events.”

Elliott wave analysis and technical analysis differs from fundamental analysis in that
fundamental analysis relies on the belief that stock markets and the people trading stocks are
rational. We at Elliott Wave International believe that — as human beings — investors and
traders are not rational, rather they follow similar “paths.” We refer to this as herding, and it is
key in the understanding of technical analysis.

Elliott Wave theory was established in the 1920s and 1930s by stock market analyst, Ralph
Nelson Elliott, who believed that there was a more common structure to markets than the chaotic
form seen by most other analysts at that time. His work on cycles and waves remains one of the
most popular methods with which technical analysts can view financial markets, despite there
being a range of views over the efficacy of his techniques.

Cycles and waves

The psychological element of trading can often provide waves rather than simple straight lines,
and these waves form one of the biggest features of Elliott’s theory. To a large extent this is a
reflection of Elliott’s studies of Charles Dow’s work, with Dow Theory stating that stock prices
typically move in waves. He also relies on cycles, which accounts for the restitutive nature of the
patterns. The theory refers mainly to waves as the key form seen throughout markets, with the
fractal nature of his waves proving that the same patterns can be seen in both short-term and
longer-term charts.

Interestingly, the fact that the corrective wave has three legs can have implications for the wider
use of highs and lows for the perception of trends. Thus, while the creation of higher highs and
higher lows will typically signal an uptrend, Elliott Wave theory highlights that you can often see
the creation of a lower high and lower low as a short-term correction from that trend. This does
not necessarily negate the trend, but instead highlights a period of retracement that is stronger
than the previous corrections seen within the impulsive move.

Rules

Wave 2 never retraces more than 100% of wave 1.

Elliott wave 2

The image above shows a break below the start point of the wave sequence, thus negating the
notion that it is wave 1.

Wave 3 cannot be the shortest of the three impulse waves.

Elliott wave 3

The image above highlights the instance when we see a third wave that is too short, thus negating
the possibility that this is a correct wave count. Therefore, the subsequent waves remain part of
the third wave rather than forming 4 and 5.

Wave 4 does not cross the final point of wave 1.

Elliott wave 4

The break below the wave 1 point clearly negates the classification of the fourth wave, instead
remaining within wave 3.

Cycles

Elliott assigned a series of categories to the waves, which highlight the fact that you will see the
same patterns within both long-term and shorter-term charts. The categories are as follows.
• Grand supercycle: multi-century

• Supercycle: multi-decade (about 40 to 70 years)

• Cycle: one year to several years (or even several decades under an Elliott Extension)

• Primary: a few months to a couple of years

• Intermediate: weeks to months

• Minor: weeks

• Minute: days

• Minuette: hours

• Sub-minuette: minutes

Fibonacci within waves

The use of corrective waves highlights the potential cross-study of Fibonacci retracements.
Elliott didn’t specifically utilise Fibonacci levels, yet traders have applied them as a way to add
greater complexity to the traditional theory.

The rules previously specified highlight which Fibonacci retracement levels could be used at
different points in the trend. Given rule three, a trader would be looking for a fourth wave to be
relatively shallow, with the 23.6%-50% levels of particular interest. We can also look for the
correct A, B, C move to be a 50%-61.8% retracement of the entire 1-5 impulse move.

Conclusion

Elliott Wave theory is something that continues to provide a sense of structure to markets for a
lot of people worldwide. The ability to constantly shift the theory when a rule is broken can
hinder the use of the theory as a means to place trades. However, it also adds a significant degree
of clarity to the art of trend recognition. How much complexity a trader wishes to add to Elliott’s
initial rules is up to them, yet it is certainly a method that many choose to place front and centre
in their market strategies.

What is The Elliott Wave Theory?

Elliott wave theory is used in technical analysis to explain a security’s price movement over time
by identifying repeating eight-wave patterns in return data. According to the theory, the market
or price action will be in cycles of five waves up, followed by the correction represented by three
waves down.

Elliott Wave Theory

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The application of Elliott wave theory patterns helps in making stock market predictions. The
theory suggests that price moves in waves, which can be recognized by studying historical stock
market price data and long-term price patterns that are rhythmic, regular, and repetitive. The
waves are categorized as impulse and corrective waves.

Table of contents

What is The Elliott Wave Theory?

Elliott Wave Theory Explained

Rules

Types

Examples

Is It Reliable?

Frequently Asked Questions (FAQs)

Recommended Articles

Key Takeaways
Elliott wave theory explains how a security’s price changes over time by identifying recurring
eight-wave patterns in return data. The eight-wave pattern is usually five waves up and three
waves down.

Ralph Nelson Elliott introduced it in the 1930s and was famous for predicting the 1935 stock
market bottom after studying long indices and historical data.

The Elliott wave theory is a technical analysis tool that claims and predicts that stock price
movements are primarily in waves rather than simple patterns. It is said to be quite similar to the
Dow theory on the common grounds that price movements occur in waves and not just line
patterns.

There are many books on Elliott wave theory that analysts can read and understand how to apply
in prevailing market conditions to make sound investment decisions.

Elliott Wave Theory Explained

Elliott wave theory is used to predict price variations primarily in the stock market; the creator of
Elliott wave theory is Ralph Nelson Elliott, an American accountant, and author; hence the
theory is named after him. He introduced it in 1930. Typically, the wave theory suggests that the
price movements are repetitive and historic, and when looked at from a broader perspective, they
look like ocean waves in long patterns.

It is essential to identify where one wave segment finishes and another starts and analyze
whether a significant correction is the completion of a wave or merely a deviation from the
general trend. As a result, it is one of the most popular forms of technical analysis used by many
portfolio managers globally.

Elliott believed that every action would give a reaction; he studied long-form and historical data
patterns and introduced the wave theory based on this. It is often compared to the Dow theory.
He proposed that the investors’ sentiment and psychological behavior can make waves in price
movements rather than just straight lines. When he studied long-form historical data, he
concluded that these waves are repetitive.

Elliott wave theory trading is extremely popular among traders as it helps in predicting future
price movements; based on that information, traders take a position in the market. Elliott wave
theory with Fibonacci retracement is a typical example among traders and analysts. Though
typically employed in the stock market, it can also be used in other financial markets.
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Rules

Elliott wave theory patterns provide a comprehensive framework for understanding market
cycles and predicting future price movements by applying a set of rules and guidelines to the
observed wave patterns. Let us understand them through the discussion below.

Wave Structure: The theory identifies two types of waves—impulse waves and corrective waves.
Impulse waves move in the direction of the main trend, while corrective waves move against it.

Wave Count: An Elliott wave sequence consists of impulsive and corrective waves, typically
labeled as 5-3-5-3-5. This represents the rhythm of market price movements.

Wave Degrees: Elliott Wave Theory categorizes waves into different degrees, including Grand
Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, and Minuette, indicating
the scale of the waves.

Wave Direction: Impulse waves (1, 3, and 5) follow the main trend and are labeled with
numbers, while corrective waves (2 and 4) move against the trend and are labeled with letters.

Fibonacci Ratios: The theory incorporates Fibonacci ratios to determine potential reversal points
and wave extensions, providing a quantitative basis for analyzing wave retracements and
extensions.

Wave Equality: In certain patterns, particularly within corrective waves, there is a tendency for
specific waves to achieve equality in terms of price or time, providing insights into potential
turning points.

Wave Alternation: Elliott Wave Theory suggests that waves of similar degree do not usually
exhibit the same pattern, promoting the idea of alternation in wave structures.
Channeling: Price movements often adhere to trend channels, and Elliott Wave analysts use
trendlines to identify potential reversal or continuation points based on wave patterns.

Confirmation: Analysts use additional technical indicators and price confirmation to strengthen
the validity of Elliott Wave analysis, enhancing the reliability of forecasted price movements.

Types

As discussed earlier, there are two types of waves under this concept. They are-

Impulse Waves: These consist of five waves, generally named Wave 1, Wave 2, Wave 3, Wave
4, and Wave 5. All these waves move in the primary trend direction, but Wave 2 and Wave 4
move in the opposite direction. It has often been sighted that the motive waves are only three and
not five in a real-time market. There are three inevitable Elliott wave theory rules regarding
motive waves.

Corrective Waves: The corrective waves, also called diagonal waves, move opposite to motive
waves. These waves are more complex and elemental than motive waves, and thus, they are
time-consuming to comprehend. The waves are in triangles, diagonals, and zig-zag. Generally, a
motive wave is the upward trend in a bull market, and corrective waves alter the tendency. This
same scenario is reversed, as in a bearish market, the corrective waves will show an upward
trend in stock price, and the motive will decrease it.

Chart

Let us look at the CFDs on WTI Crude Oil chart below to better understand the concept of Elliot
Wave Theory.

Source

As we can see above, the first five waves (1, 2, 3, 4, and 5) move in the main trend’s direction.
On the other hand, the remaining 3 waves (A, B, and C) move in a correction. Hence, overall, it
is a 5-3 move. The first five waves lead to the formation of an impulse, while the next three
denote the corrective waves. From the chart, it is clear that this theory can help in the
identification of trends in the market. Thus, utilizing this tool can help traders exit their trades at
the right time and safeguard their profits.
If a person wants to look at more charts concerning Elliot the wave theory, they can consider
observing more charts that involve this theory on TradingView.

Examples

Let us understand the practical applicability of Elliott wave theory trading through the examples
below.

Example #1

Glenn, a financial analyst is applying Elliott Wave Theory to analyze a stock’s price movements.
The analyst identifies a bullish trend and observes a five-wave sequence representing an impulse
wave, denoted as waves 1 through 5. Following this upward movement, the analyst identifies a
corrective wave, labeled as wave A, which retraces a portion of the preceding impulse wave.

As the correction completes, he anticipates another impulsive move to the upside, forming waves
B and C of the corrective sequence. The entire pattern, when visualized, reflects the classic 5-3-
5-3-5 structure of this Theory. Additionally, Glenn may use Fibonacci ratios to pinpoint potential
reversal levels or extensions within each wave, providing a quantitative dimension to the
analysis.

Example #2

The analysis of the stock price movement of Gamestop starts from a significant low, which is at
$2.57, seen on April 3 2020. The evaluation and interpretation based on the theory explain that
wave 1 of the five waves of the bull cycle went from $2.57 to a peak of $159.18, seen on 25
January 2021.

It should be observed that wave 2 corrected wave 1, a 61.8% retracement, and the third wave
reached 200% of wave 1. Again another wave, wave 4, brought a correction which presented
another chance to buy, as the stock dropped to close to the 38.2% retracement of wave 3. Finally,
wave 5 finished at $483.
Traders holding the company’s shares should have intended to sell them when the price got
closer to this objective. When the fifth wave finished, the chances of a correction rose, and given
the already irrational swings that had occurred, the chances of traders trying to buy from a point
beyond the wave 5 level may decrease. As expected, a correction quickly decreased the price to
almost a 78.6% retracement of the bull cycle.

Is It Reliable?

While this theory is one of the most used technical analysis tools by portfolio managers, let us
cross-check if it is actually as reliable through the points below.

The reliability of Elliott Wave Theory is influenced by the subjective nature of wave
interpretation, allowing for different analysts to identify different wave counts.

The theory’s complexity and the multitude of rules and guidelines can make it challenging for
analysts to consistently apply and interpret correctly, affecting its reliability.

Its effectiveness may vary under different market conditions, and in highly unpredictable or
chaotic markets, the application of Elliott Wave Theory can be less reliable.

Analysts often use additional technical indicators and price confirmation to enhance reliability,
but these tools don’t eliminate the inherent subjectivity of Elliott Wave analysis.

While it has demonstrated accuracy in specific historical patterns, its reliability remains a topic
of debate among traders and analysts due to its sensitivity to interpretation and market dynamics.

Frequently Asked Questions (FAQs)

What is the difference between Dow’s theory and Elliott Wave Theory?

The Elliott wave theory resembles the Dow theory; both studies theorize the same objective that
prices in a market move in waves rather than just straight lines. However, the Elliott wave theory
was a much better explanation and detailed the concept than the Dow theory. The main
difference is that the Elliott theory breaks markets down into fractals.

How important is Elliott Wave Theory?

The theory’s application is essential in predicting the trend and the correction following the
trend. In other words, identifying trends and corrections that will probably take place soon will
help the traders protect the profit or reduce the loss.
How to apply the Elliott wave theory?

It is a technical analysis, and the most common technique to apply is to spot an upward trend
which is an impulse wave, move forward with it, and there is a high chance that it will reverse
after five complete waves. Then, depending on the movement and strategy, the trader can decide
on the entry or exit point.

What is the Elliott Wave Theory?

The Elliott Wave Theory is a technical analysis technique developed by American accountant
and author Ralph Nelson Elliott in the 1930s. Elliott studied several years of stock market data
across various indices and was the first to predict a stock market bottom in 1935. Since then, the
theory’s become a reliable tool for various portfolio managers across the world. Elliott waves are
used with other technical analysis techniques to predict market movements and trading
opportunities.

Fig.1: Elliott
Waves – Bull Market (left to center). Bear Market (right to center). Source

The Elliott Wave Theory suggests that stock price movements can be reasonably predicted by
studying price history as the markets move in wave-like patterns driven by investor
 sentiment. Like ocean waves, the movements are repetitive, rhythmic, and timely. Moreover, the
wave patterns are not seen as certain to occur in the markets; they only provide a probable
scenario of stock price behavior.

Summary

 Elliott waves are used in technical analysis to determine price movements. Elliott’s Wave Theory
mainly comprises two kinds of waves – motive (impulse waves) and corrective waves.
 A motive wave consists of five waves – three impulse waves and two retrace waves.
 A corrective wave consists of three waves – A, B, and C. Waves A and C are impulse waves,
while Wave B is a retrace wave.
 Real-world markets often exhibit three-wave motive trends instead of five-wave motive trends.

Motive and Corrective Waves

Elliott’s Wave Theory mainly comprises two kinds of waves – motive (impulse waves) and
corrective waves. Impulse or motive waves are movements that occur in the direction of a trend.
On the other hand, corrective waves occur in a direction opposite to the ongoing trend. The
diagram below clearly illustrates the movements of Elliott waves.

Fig. 2: Elliott Wave Forecast. Source

Let’s assume that we are in a bull market. In other words, one motive wave is driving the stock
price up. One motive wave comprises five waves – 1, 2, 3, 4, and 5. Waves 1, 3, and 5 are
impulsive in nature as they move the stock price in a particular direction (here, upwards, but
even downward stock movement can constitute an impulse wave). Wave 2 is a smaller
downward movement after wave 1, and wave 4 is a smaller downward movement after wave 3.
The smaller downward movements after impulse waves are called retrace waves.

Furthermore, impulse waves (1, 3, and 5) are each divided into five waves. On observation, one
can notice that waves 1, 3, and 5 comprise smaller upward and downward movements that, upon
counting, amount to five waves. The movements are identified as ((i)), ((ii)), ((iii)), ((iv)), and
((v)).

On the other hand, retrace waves (2 and 4) are broken up into upward and downward movements
of three waves, represented by ((a)), ((b)), and ((c)).

Put together, waves 1, 2, 3, 4, and 5 make up a single motive wave.

A corrective wave will take the stock price down. The correction occurs in three waves – A, B,
and C. Waves A and C are made up of five waves characterized by ((i)), ((ii)), ((iii)), ((iv)), and
((v)). On the other hand, Wave B is made up of three waves identified by ((a)), ((b)), and ((c)).

In a bull market, a motive wave takes the stock price upwards, while a corrective wave reverses
the trend. But, in a bear market, a motive wave would take the stock price down, and a corrective
wave will take the stock price up. Therefore, in a bear market, the Elliott waves diagram shown
above will be inverted. It will consist of five waves (1, 2, 3, 4, and 5) taking the price down and
three waves (A, B, and C) taking the price up.

Deconstructing Motive Waves

Some general guidelines can be followed to identify a motive wave:

1. Wave 2 cannot be more than 100% of Wave 1.

2. Wave 3 cannot be the shortest wave of the three impulse waves (1, 3, and 5).
3. The price range of Waves 1 and 4 cannot overlap.

Elliott Wave Theory Applied to Markets

In real-time markets, it was observed that a motive wave could comprise three waves instead of
five. In fact, most of the time, the market will see a motive wave that is composed of three
waves. It is also possible that the market keeps moving in corrective waves. Therefore, three-
wave trends are more common than five-wave trends.

Use of Fibonacci Ratios in Elliott Wave Theory

The Fibonacci summation series takes 0 as the first number. The next number is obtained by
adding 1 to 0. Then, the series is derived by taking the previous two numbers and adding them to
obtain the next number. The Fibonacci summation series looks like 0, 1, 1, 2, 3, 5, 8, 13, 21, 34,
to infinity. Fibonacci ratios are derived by dividing two Fibonacci numbers. The ratios are used
to determine levels of support and resistance in the markets.

In Elliott Wave Theory, Fibonacci retracement is the use of Fibonacci ratios to determine where
a correction ends so that the primary trend can begin again. Fibonacci retracements measure the
depth of pullbacks in a trend. For example, Wave 2 can be 50% of the length of Wave 1.

Another widely used tool is Fibonacci extensions. Fibonacci extensions are used to determine the
turning points in a primary trend. In a bull market, they indicate where a motive wave can go
before a correction. In a bear market, they can be used to determine support levels. Fibonacci
extensions are used to measure stock price levels at which profits can be realized.
The chart above shows this eight-wave structure in a declining market. Of course, it ends lower
than where it started. If you saw this pattern on a chart, depending on the larger picture, you
might expect another five waves down.

Please keep in mind that this is simply a motive wave and a corrective wave. All markets
advance and correct. The Elliott Wave Theory provides specific types of patterns that the market
uses to do this, which we will cover below, but it all fits within this general cycle structure.

Fractal Nature

If we incorporate our expanded motive and corrective waves together, we will see that they make
a more detailed general Elliott structure. We can see five advancing waves in the motive wave
that make up Wave I, as well as three declining waves in the corrective wave that make up Wave
II. However, notice that in Waves 1 and 2 of Wave I, the general Elliott structure forms. This
structure forms on both a larger scale and a smaller scale within the same picture.

This is an example of the fractal nature of the Elliott Wave patterns. A fractal is a curve or
geometric figure, each part of which has the same statistical character as the whole, and anything
that resembles this type of formation is said to be fractal. Within the Elliott Wave structure, this
is evidenced by the expanding and contracting similarity of wave structures. Wave I is the next
higher degree of trend for Wave 1, but within Wave 1 and 2 is the 5-3 pattern of the full Elliott
Wave cycle. The 5-3 pattern then repeats for Waves 3 and 4, and for waves A and B as well
(except in the declining direction).

There are actually three degrees of trend shown in the chart above. Waves I and II form the
larger degree cycle. The next degree down are the waves that are labeled 1, 2, 3, 4, 5, A, B, and
C. And the next degree down are the waves labeled i, ii, iii, iv, v, a, b, and c. In theory, this
pattern expands to infinity and shrinks to infinity and constitutes what is known as a fractal, an
infinitely contracting and expanding pattern.
Elliott discovered, by observation, that the markets were fractal in nature. No matter how big or
small the wave degree, motive waves take on a 5-wave sequence and corrective waves usually
take on a 3-wave sequence. He classified patterns that showed up in higher degrees of trend and
saw that those same types of patterns repeated on lower degrees of trends.

The chart above shows the same picture in a declining market. See if you can spot the different
degrees of trend.

Elliott Wave is not a trading technique. There are no specific rules of entry or exit, nor is there
one “right” way to use it in trading. As a result, the use of Elliott Wave has been avoided by
many traders and technical analysts, not due to a lack of understanding but because of the
apparently subjective nature of how it may be applied. Nonetheless, there are those who have
successfully used Elliott Wave patterns in their trading. The Theory continues to attract a wide
following, both with individual investors as well as professional traders. Advocates tend to apply
various indicators to help them in trading specific Elliott Wave patterns, although those
techniques are unique to the people who developed them.

If you are going to perform Elliott Wave analysis, you will be making “wave-counts.” This
simply means that you will be labeling the waves to see how they conform to the Elliott Wave
pattern, allowing you to anticipate market movement. The next section will give you some
guidelines on labeling the wave-counts.
Elliott Wave Theory, is one important method of technical analysis that finance traders
use to analyze financial market cycles. The Elliot Wave theory was created in the 1930s
by Ralph Nelson Elliott and is based on the premise that financial markets, as well as
other collective human activities, move in repeated patterns or waves.

According to the hypothesis, these patterns can be detected and used to forecast future
market behavior. The Elliott Wave Principle is based on five waves in the trend’s
direction and three waves in the trend’s corrective or retracement. The theory specifies
particular rules and recommendations for recognizing and categorizing certain wave
patterns, such as wave direction, length, and momentum.

The Elliott Wave Theory is frequently utilized to make informed trading decisions in the
stock, Forex (FX), and commodities markets.

What is the meaning of Elliot Wave Theory?

The Elliott Wave Theory is a technical analysis concept used to forecast financial
market trends, particularly in the stock market. Elliot Wave Theory is a technical
analysis approach that suggests that financial markets, such as stocks or currencies,
move in a series of predictable and repetitive waves. These waves reflect the natural
behavior of market participants, who alternate between optimism and pessimism as
they react to various economic and financial events.

Trend analysis, support and resistance levels, and chart patterns are other technical
analysis methods employed in the stock market. The Elliott Wave Theory’s accuracy in
forecasting future price changes is a source of contention among traders and analysts.
While certain supporters say that the theory can provide useful insights into market
behavior, others challenge its dependability and efficacy.

What is the background History of Elliott Wave

Theory?
Ralph Nelson Elliott created the Elliott Wave Theory in the 1930s. Elliott was a
competent accountant who noted that stock market values moved in a definite pattern,
which he referred to as “waves”. He developed his idea by combining complicated
mathematics with market data. Below is an image of what these waves can look like.
 Backgr
ound History of Elliott Wave Theory
Elliott’s discovery that market prices moved in repeating cycles inspired the Elliott Wave
Theory. He saw that following a price fluctuation, the market will pause and consolidate
before continuing in the opposite direction. Elliott felt that these cycles may be foreseen
and utilized to forecast market prices in the future.

Elliott Wave Theory is predicated on the idea that markets move in cycles. The cycles
are made up of five waves in the same direction as the main trend, followed by three
corrective waves in the opposite direction. Elliott felt that market prices followed a
predictable pattern, which can be utilized to forecast future market moves.

Traders and investors employ Elliott Wave Theory to anticipate probable market moves.
Elliot Wave Theory is an essential component of technical analysis and is used to assist
traders and investors in making more informed decisions. Traders and investors utilize
Elliott Wave Theory to maximize profits and avoid losses by forecasting probable
support and resistance levels.

How does Elliott Wave Theory function?

Elliott Wave Theory is a technical analysis concept that aims to anticipate stock price
movements in the future. Ralph Nelson Elliott invented it in the early twentieth century.
According to the hypothesis, stock prices follow recurrent wave patterns that may be
forecast by evaluating previous price data.
 Elliott
Wave Theory function
Stock prices move in a predictable pattern of impulse and corrective waves, with each
wave serving a specific purpose, according to the idea. The impulse wave represents
the market’s movement in the direction of the trend, whereas the corrective wave
describes the market’s response against the trend. According to Elliott’s Wave Theory,
the market moves in five waves in the direction of the trend, followed by three corrective
waves. The five waves look like below.

Elliott Wave Theory is useful for stock traders and investors because it gives insight into
market psychology, which can be utilized to create more accurate forecasts regarding
the direction of stock prices in the future. Using this idea, traders predict if a trend is
poised to reverse or continue and capitalize on present market circumstances.

How to trade using Elliott Wave Theory in the

Stock Market?
Elliott Wave Theory uses the observation that stock prices often move in repetitive
cycles. Traders look for a pattern of five consecutive waves, with the third wave being
the longest and strongest. The theory predicts that after the completion of this 5-wave
sequence, prices will reverse direction. For example, see the graph below.
Take Reliance Industries as an example in the stock market of how to trade utilizing the
Elliott Wave Theory. Reliance Industries is a significant Indian company that operates in
nearly every sector of the Indian economy. We can see from the price movement of this
company that it has moved in a 5-wave pattern during the last several months.
The third wave, which is usually the longest and most powerful, has been particularly
evident. As a result, traders should consider that a fourth wave is likely to begin and that
the price may soon move in the other direction. Traders potentially profit from this price
reversal by entering a trade in the opposite direction of the third wave.

How often do Traders use the Elliott Wave Theory for

Analyzing Stock Market Prices?
Elliot Wave Theory, despite its antiquity, is still frequently utilized today, particularly by
technical analysts. It is regarded to be especially efficient when combined with other
indicators like candlesticks and volume charts.

Experienced traders frequently depend on this idea to make educated judgments when
entering and departing the market. Furthermore, Elliot Wave Theory is used to generate
price objectives with reasonable accuracy, making it a valuable tool for investors.

What are the Five Wave Patterns (Motive) of Elliott

Wave Theory?
There are five wave patterns for Elliot Wave Theory. They have named waves one to
five. Look at the below graph to see how the waves look.

1. Wave 1
Wave 1 begins the accumulation phase and the formation of the five-wave pattern.
Wave 1 can be difficult to identify as it often looks as a short pullback against the
previous trend. Compared to other waves, Wave 1 is highly uncertain. This is why
traders confirm the establishment of Wave1 after the formation of Wave 2.

2. Wave 2
Wave 2 marks the bottom of a five-wave structure. Wave 2 is comparatively shorter
than Wave 1 as it must not go below the bottom of it. The pattern is considered as
flawed if Wave 2 breaks below Wave 1. Wave 2 is a retracement of Wave 1. It goes
against the direction of Wave 1.

3. Wave 3
Wave 3 is the longest and strongest wave in a five-wave structure. Wave 3 is an
extension of Wave 1. Traders often try to catch this wave as it offers an explosive price
move. This wave represents the confidence of market participants in the newly
established trend. Compared to other waves, Wave 3 is easy to spot because of its
length.

4. Wave 4
Wave 4 is the final retracement of a five-way structure. Wave 4 is comparatively weaker
than Wave 2. This is why, Wave 3 and Wave 4 together often look like a wage or a flag
and pole chart pattern. On the other hand, if Wave 4 goes below the bottom of Wave 3,
then the five-wave pattern is considered as flawed.

5. Wave 5
Wave 5 is the final wave of a five-wave structure. Wave 5 marks the end of the newly
established trend and indicates that a correction is pending in the market. This wave is
typically the weakest wave in a five-wave structure. Generally, traders and investors
start booking their profits as the Wave 5 is the final impulse move of the existing trend.

What are the Three Wave Patterns (Corrective) of

Elliot Wave Theory?
Three-wave patterns or Elliott Wave corrective patterns usually occur after the
completion of the five-wave pattern. The three-wave pattern is a move that is against
the established trend. The three waves in the three-wave pattern are –

1. Wave A
Wave A is the first corrective wave. Wave A is a sharp retracement of Wave 5 as it
moves against the established trend and confirms a price correction. As the move is
strong and sharp, traders can identify Wave A with ease.
 2. Wave B
Wave B is the second corrective wave. Wave B forms in the direction of the previously
established trend as the market participants try in resuming the trend. It must not go
above the high of Wave A. The corrective wave pattern is flawed and the price can
continue to go in the direction of the existing trend, if it breaks the high of Wave A.

3. Wave C
Wave C is the third corrective wave. Wave C resumes the correction and breaks below
the low of Wave B. The length of this wave is generally higher than the length of Wave
B. Wave C officially marks the correction of the previous five-wave structure.

Which Elliot Wave is the strongest?

Wave 3 is the strongest wave amongst all Elliot wave patterns. Wave 3 is often driven
by the optimism and confidence that market participants show in the existing trend. Due
to its length, Wave 3 is also easier to spot.

Which Elliot Wave is the weakest?

Wave 5 is the weakest wave amongst all Elliot wave patterns. Wave 5 marks the top of
the Elliot wave’s five-wave pattern. Investors and traders look to book their profits in this
wave.

How to Calculate Elliot Wave Theory?

Calculating Elliot waves can get tricky as the reading of these waves is largely
subjective. Elliott wave theory is also largely criticized due to this factor. But as you
practice with these waves, your eyes get used to identifying these waves. Here are 3
tips that will help you in identifying Elliot waves –

1. Trend identification –
The first and foremost step in calculating the waves is to first identify the main trend.
This step will be much easier for you if you are used to reading charts. On the other
hand, try reading the chart and understand the uptrend and downtrend structure in the
chart if you are a beginner.

2. Mark the Elliot waves –

Now that you have successfully identified the trend, it is time for you to mark the waves
with the help of the rules and guidelines of Elliott wave theory. Remember, the more you
practice, the better you will get at accurately identifying the motive waves.

3. Use another technical indicator –

Using another technical indicator will enhance your edge. Traders often use technical
indicators such as RSI (Relative strength index) and Fibonacci retracement to further
predict the top and bottom of a pattern.
What are the Elliot Wave Theory Rules and
Guidelines?
Elliott wave theory’s rules and guidelines ease the identification of waves for a trader.
Elliott wave theory consists of 5 simple rules and guidelines –

1. Motive waves or impulse waves are a five-wave pattern. It should always have 5
waves that are known as Wave 1, 2, 3, 4, and 5 respectively.
2. Corrective wave is a three-wave pattern. It should always have 3 waves that are
also known as Wave A, B, and C.
3. In a five-wave structure, Wave 2 should never go below the low of Wave 1. The
pattern is considered to be incorrect if wave 2 violates the bottom of wave 1.
4. In motive waves, wave 3 can never be shorter than wave 1 and wave 5.
5. In a five-wave structure, wave 4 cannot go below the low of wave 3.

How to use Elliot Wave Theory in Technical

Analysis?
Elliott wave theory is a technical analysis tool that is mostly used to forecast price
movements. Elliott wave theory analyzes the collective market behavior and predicts
price movements based on the repetitive nature of the market. Here are 2 things you
can follow to further enhance the Elliott wave theory in technical analysis –
1. Use the Elliot wave theory with other technical indicators –
Using the Elliot wave theory with other technical indicators will certainly improve your
chances of correctly predicting a potential top or bottom. Traders use RSI (Relative
strength index) and look for a bullish or bearish RSI divergence at the end of a bullish or
bearish Five-wave pattern. Traders also use Fibonacci retracement and extension to
predict the potential top or bottom of a five-wave pattern.

2. Look for reversal candlestick patterns at the end of a five-wave pattern –

Reversal candlestick patterns play a very crucial role when it comes to reading a price
chart. For example, an evening star at the end of a bullish five-wave pattern will add
double confirmation to the fact that a potential correction is pending and it is the right
time to book profits and vice versa.

What is an example of Elliot Wave Theory?

Examples of Elliott wave theory can be seen in every price chart. Following is an
example of the Elliot wave theory on a Nifty 50 chart –

As you can see in the above image, this is an example of the Elliot wave theory on a
daily chart. The above example fulfills every rule and guideline of the Elliott wave
theory. For example –

 Wave 2 has not violated Wave 1’s low

  Wave 3 is the longest and strongest wave in this five-wave structure
 Wave 4 has not violated Wave 3’s low

What is the relation between Elliot Wave Theory

and Fibonacci?
Elliot waves and Fibonacci tools are used by traders to identify the potential support
and resistance of a price chart. Elliott wave theory and Fibonacci tools are often used
together.

Fibonacci retracement is used in the Elliot wave theory to identify the potential
retracement levels of the waves. Fibonacci ratios like 0.38%, 0.50% and 0.618% are
given much significance. Whereas, Fibonacci extension is used to further predict the
extent to which a wave can go. Ratios like 1.27%, 1.414% and 1.618% are given much
importance.

What do the Critics say about Elliott wave theory?

Elliott wave theory has been a subject of controversy ever since it was founded.
Following are the 3 most common things that critics argue when it comes to the Elliot
wave theory –

1. Elliott wave theory is too subjective –

Elliott wave theory requires a trader to analyze the chart carefully and mark the waves
which he thinks are correct. Critics claim that two traders looking at the same chart can
end up marking different waves. This leads to confusion and can also lead to faulty
analysis of the price chart.

2. Elliott wave theory is hard to understand –

Elliott wave theory is the practice of identifying waves and predicting future price
movement. Critics argue that identifying the waves effectively can get too complex and
confusing for a beginner and even an experienced trader.

3. Elliott wave theory cannot adapt to the nature of the market –

As the market is constantly changing and evolving, critics argue that the ideology
behind the Elliott wave theory says that the market moves in predictable waves. This
can prove to be incorrect as every price movement is unique and is affected by various
market factors.

What is the advantage of Elliot Wave Theory?

Elliott wave theory has been a subject of controversy for a long time but it does have its
advantages. Following are the 3 major advantages of the Elliot wave theory –

1. Universal adaptation –
Motive and corrective waves can be seen on every stock, commodity, currency price
chart. The Elliott wave theory offers many opportunities across all types of markets.

2. Identifies the main trend –

Elliott wave theory helps a trader in identifying the main trend of the market. Elliott wave
theory can help a trader in predicting a pending correction in the market as well. This
helps a trader in taking his trading related decisions.

3. Enhances a trader’s edge when used with other indicators –

Elliott wave theory can be used with other technical indicators. Traders use indicators
like RSI and Fibonacci to effectively predict the potential support and resistance on a
price chart.

What is the limitation of Elliot Wave Theory?

The limitations of Elliott wave theory are the main reason why it faces much criticism.
Following are the 3 limitations of the Elliot wave theory –

1. Elliott wave theory is highly subjective –

Elliott wave theory requires a trader to mark the waves according to his own individual
perception about the current market data. This can result in confusion as other traders
can interpret the same data differently and mark the waves in a completely different
way.

2. Elliott wave theory is difficult to understand –

As a beginner trader, identifying and marking Elliot waves correctly can get very difficult.
This results in faulty analysis of the price chart.

3. Elliott wave theory believes that market moves can be predicted –

The stock market is constantly changing and is affected by various other factors
constantly. Sometimes, prices can move drastically because of the latest news in the
market and it may not move according to its past market data.

Is the Elliot Wave Theory accurate?

No, Elliott wave theory cannot be accurate at all times. The accuracy of the Elliot wave
theory depends on factors like liquidity, market situation, the ability of a trader to mark
Elliot waves correctly, etc.

At the same time, it is also important for traders to understand that no technical tool can
be accurate 100% of the time. There is no holy-grail strategy when it comes to the stock
market.

Is Elliot Wave bullish or bearish?

Elliot waves can be both bullish or bearish. Elliott wave theory can help a trader predict
the market’s potential top as well as the bottom. During an uptrend, a trader can mark
the five-wave pattern in a downward to upward fashion. Similarly, during a downtrend, a
trader can mark the five-wave pattern in an upward to downward fashion.

Is Elliot Wave good for trading?

Yes, Elliot waves can prove to be good for trading. Elliot waves are beneficial as it helps
a trader in identifying a potential entry and exit point. Elliott wave theory is also used to
identify major trends and potential corrections in the market.

But it should also be noted that like all other technical indicators, Analysis based on
Elliot wave theory will not work every time.

Is it hard to learn Elliot Wave theory?

Yes, Elliott wave theory can get hard to learn. Learning Elliot wave theory gets difficult
due to the fact that it involves identifying and marking complex market patterns. It takes
time for a trader’s eyes to get used to identifying Elliot waves.

It should also be noted that as you spend time practicing on a chart, you will be able to
identify and mark Elliot waves successfully.

Can you also use Elliot Wave Theory in Fundamental

Analysis?
No, you cannot use Elliot wave theory in fundamental analysis. Elliot wave is a technical
analysis tool which predicts the future price movement based on the previous market
data.

However, you can use Elliott wave theory along with fundamental analysis. For
example, if a company has declared bad earnings and their stock chart has just
completed a five-wave structure, then it is most likely that the company’s stock will
correct and in this case, you can take a short position with conviction.

Which is more accurate, Elliot Waves or

Candlestick Pattern?
It is difficult to compare the accuracy of Elliot waves and candlestick patterns. The
accuracy of Elliot waves and Candlestick patterns depends on factors like liquidity,
market situation, a trader’s skill etc.

However, traders can use both of these tools together to enhance their edge in the
markets as both tools are used for identifying the potential tops and bottoms within a
price chart.
1) Elliott Wave Theory: Modern Theory for 21st Century Market
1.1 What is Elliott Wave Theory?
Elliott Wave Theory is named after Ralph Nelson Elliott (28 July 1871 – 15 January 1948). He was an
American accountant and author. Inspired by the Dow Theory and by observations found throughout nature,
Elliott concluded that the movement of the stock market could be predicted by observing and identifying a
repetitive pattern of waves.
Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns
and making detailed market predictions based on the patterns. Elliott based part his work on the Dow Theory,
which also defines price movement in terms of waves, but Elliott discovered the fractal nature of market
action. Elliott first published his theory of the market patterns in the book titled The Wave Principle in 1938.
1.2 Basic Principle of the 1930’s Elliott Wave Theory
Simply put, movement in the direction of the trend is unfolding in 5 waves (called motive wave) while any
correction against the trend is in three waves (called corrective wave). The movement in the direction of the
trend is labelled as 1, 2, 3, 4, and 5. The three wave correction is labelled as a, b, and c. These patterns can be
seen in long term as well as short term charts.
Ideally, smaller patterns can be identified within bigger patterns. In this sense, Elliott Waves are like a piece of
broccoli, where the smaller piece, if broken off from the bigger piece, does, in fact, look like the big piece.
This information (about smaller patterns fitting into bigger patterns), coupled with the Fibonacci relationships
between the waves, offers the trader a level of anticipation and/or prediction when searching for and
identifying trading opportunities with solid reward/risk ratios.

1.3 The Five Waves Pattern (Motive and Corrective)

In Elliott’s model, market prices alternate between an impulsive, or motive phase, and a corrective phase on all
time scales of trend. Impulses are always subdivided into a set of 5 lower-degree waves, alternating again
between motive and corrective character, so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller
retraces of waves 1 and 3.
In Figure 1, wave 1, 3 and 5 are motive waves and they are subdivided into 5 smaller degree impulses labelled
as ((i)), ((ii)), ((iii)), ((iv)), and ((v)). Wave 2 and 4 are corrective waves and they are subdivided into 3 smaller
degree waves labelled as ((a)), ((b)), and ((c)). The 5 waves move in wave 1, 2, 3, 4, and 5 make up a larger
degree motive wave (1)
Corrective waves subdivide into 3 smaller-degree waves, denoted as ABC. Corrective waves start with a five-
wave counter-trend impulse (wave A), a retrace (wave B), and another impulse (wave C). The 3 waves A, B,
and C make up a larger degree corrective wave (2)
In a bear market the dominant trend is downward, so the pattern is reversed—five waves down and three up

1.4 Wave Degree

Elliott Wave degree is an Elliott Wave language to identify cycles so that analyst can identify position of a
wave within overall progress of the market. Elliott acknowledged 9 degrees of waves from the Grand Super
Cycle degree which is usually found in weekly and monthly time frame to Subminuette degree which is found
in the hourly time frame. The scheme above is used in all of EWF’s charts.

1.5 The Rise of Algorithmic / Computer-based Trading

The development of computer technology and Internet is perhaps the most important progress that shape and
characterize the 21st century. The proliferation of computer-based and algorithmic trading breed a new
category of traders who trade purely based on technicals, probabilities, and statistics without the human
emotional aspect. In addition, these machines trade ultra fast in seconds or even milliseconds buying and
selling based on proprietary algos.
No doubt the trading environment that we face today is completely different than the one in the 1930’s when
Elliott first developed his wave principle. Legitimate questions arise whether Elliott Wave Principle can be
applied in today’s new trading environment. After all, if it’s considered to be common sense to expect today’s
cars to be different than the one in the 1930’s, why should we assume that a trading technique from 1930 can
be applied to today’s trading environment?

1.6 The New Elliott Wave Principle – What is Changing in Today’s Market
The biggest change in today’s market compared to the one in 1930s is in the definition of a trend and counter-
trend move. We have four major classes of market: Stock market, forex, commodities, and bonds. The Elliott
Wave Theory was originally derived from the observation of the stock market (i.e. Dow Theory), but certain
markets such as forex exhibit more of a ranging market.
In today’s market, 5 waves move still happen in the market, but our years of observation suggest that a 3
waves move happens more frequently in the market than a 5 waves move. In addition, market can keep moving
in a corrective structure in the same direction. In other words, the market can trend in a corrective structure; it
keeps moving in the sequence of 3 waves, getting a pullback, then continue the same direction again in a 3
waves corrective move. Thus, we believe in today’s market, trends do not have to be in 5 waves and trends can
unfold in 3 waves. It’s therefore important not to force everything in 5 waves when trying to find the trend and
label the chart.

2) Fibonacci
2.1 Introduction
Leonardo Fibonacci da Pisa is a thirteenth century mathematician who discovered the Fibonacci sequence. In
1242, he published a paper entitled Liber Abacci which introduced the decimal system. The basis of the work
came from a two-year study of the pyramids at Giza. Fibonacci is most famous for his Fibonacci Summation
series which enabled the Old World in the 13th century to switch from Roman numbering (XXIV = 24) to the
Arabic numbering (24) that we use today. For his work in mathematics, Fibonacci was awarded the equivalent
of today’s Nobel Prize.
2.2 Fibonacci Summation Series
One of the most popular discoveries by Leonardo Fibonacci is the Fibonacci Summation series. This series
takes 0 and adds 1 as the first two numbers. Succeeding numbers in the series adds the previous two numbers
and thus we have 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 to infinity. The Golden Ratio (1.618) is derived by
dividing a Fibonacci number with another previous Fibonacci number in the series. As an example, 89 divided
by 55 would result in 1.618.

2.3 Fibonacci Ratio Table

Various Fibonacci ratios can be created in a table shown below where a Fibonacci number (numerator) is
divided by another Fibonacci number (denominator). These ratios, and several others derived from them,
appear in nature everywhere, and in the financial markets. They often indicate levels at which strong resistance
and support will be found. They are easily seen in nature (seashell spirals, flower petals, structure of tree
branches, etc), art, geometry, architecture, and music.
2.5 Relation Between Fibonacci and Elliott Wave Theory
Fibonacci Ratio is useful to measure the target of a wave’s move within an Elliott Wave structure. Different
waves in an Elliott Wave structure relates to one another with Fibonacci Ratio. For example, in impulse wave:
 • Wave 2 is typically 50%, 61.8%, 76.4%, or 85.4% of wave 1
 • Wave 3 is typically 161.8% of wave 1
 • Wave 4 is typically 14.6%, 23.6%, or 38.2% of wave 3
 • Wave 5 is typically inverse 1.236 – 1.618% of wave 4, equal to wave 1 or 61.8% of wave 1+3
Traders can thus use the information above to determine the point of entry and profit target when entering into
a trade.
3) Motive Waves
In Elliott Wave Theory, the traditional definition of motive wave is a 5 wave move in the same direction as the
trend of one larger degree. There are three different variations of a 5 wave move which is considered a motive
wave: Impulse wave, Impulse with extension, and diagonal.
EWF prefers to define motive wave in a different way. We agree that motive waves move in the same direction
as the trend and we also agree that 5 waves move is a motive wave. However, we think that motive waves do
not have to be in 5 waves. In today’s market, motive waves can unfold in 3 waves. For this reason, we prefer to
call it motive sequence instead.

3.1 Impulse

Guidelines
 • Impulse wave subdivide into 5 waves. In Figure 2, the impulse move is subdivided as 1, 2, 3,
4, 5in minor degree
 • Wave 1, 3, and 5 subdivision are impulse. The subdivision in this case is ((i)), ((ii)), ((iii)), ((iv)),
and ((v)) in minute degree.
 • Wave 2 can’t retrace more than the beginning of wave 1
 • Wave 3 can not be the shortest wave of the three impulse waves, namely wave 1, 3, and 5
 • Wave 4 does not overlap with the price territory of wave 1
 • Wave 5 needs to end with momentum divergence
Fibonacci Ratio Relationship
 • Wave 2 is 50%, 61.8%, 76.4%, or 85.4% of wave 1
 • Wave 3 is 161.8%, 200%, 261.8%, or 323.6% of wave 1-2
 • Wave 4 is 14.6%, 23.6%, or 38.2% of wave 3 but no more than 50%
 • There are three different ways to measure wave 5. First, wave 5 is inverse 123.6 – 161.8%
retracement of wave 4. Second, wave 5 is equal to wave 1. Third, wave 5 is 61.8% of wave 1-3
Guidelines
 • Special type of motive wave which appears as subdivision of wave 1 in an impulse or
subdivision of wave A in a zigzag
 • In Figure 4A, the leading diagonal is a subdivision of wave 1 in an impulse. In Figure 4B, the
leading diagonal is a subdivision of wave A in a zigzag
 • Leading diagonal is usually characterized by overlapping wave 1 and 4 and also by the wedge
shape but overlap between wave 1 and 4 is not a condition, it may or may not happen
 • The subdivision of a leading diagonal can be 5-3-5-3-5 or 3-3-3-3-3. The examples above
show a leading diagonal with 5-3-5-3-5 subdivision
3.4 Ending Diagonal

Guidelines
 Special type of motive wave which appears as subdivision of wave 5 in an impulse or
subdivision of wave C in a zigzag
  • In Figure 5A, the ending diagonal is a subdivision of wave 5 in an impulse. In Figure 5B, the
ending diagonal is a subdivision of wave C in a zigzag
 • Ending diagonal is usually characterized by overlapping wave 1 and 4 and also by the wedge
shape. However, overlap between wave 1 and 4 is not a condition and it may or may not
happen
 • The subdivision of an ending diagonal is either 3-3-3-3-3 or 5-3-5-3-5
3.5 Motive Sequence
Motive waves move in the same direction of the primary trend, but in today’s time, we believe it doesn’t
necessarily have to be in impulse. We instead prefer to call it motive sequence.We define a motive sequence
simply as an incomplete sequence of waves (swings). The structure of the waves can be corrective, but the
sequence of the swings will be able to tell us whether the move is over or whether we should expect an
extension in the existing direction.
Motive sequence is much like the Fibonacci number sequence. If we discover the number of swings on the
chart is one of the numbers in the motive sequence, then we can expect the current trend to extend further.
Motive Sequence: 5, 9, 13, 17, 21, 25, 29, …

4) Waves Personality
4.1 Wave 1 and wave 2

Wave 1: In Elliott Wave Theory, wave one is rarely obvious at its inception. When the first wave of a new bull
market begins, the fundamental news is almost universally negative. The previous trend is considered still
strongly in force. Fundamental analysts continue to revise their earnings estimates lower; the economy
probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied
volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert
many technical analysts
Wave 2: In Elliott Wave Theory, wave two corrects wave one, but can never extend beyond the starting point
of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds,
and “the crowd” haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs
appear for those who are looking: volume should be lower during wave two than during wave one, prices
usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should
fall in a three wave pattern

4.2 Wave 3
Wave 3: In Elliott Wave Theory, wave three is usually the largest and most powerful wave in a trend (although
some research suggests that in commodity markets, wave five is the largest). The news is now positive and
fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and
shallow. Anyone looking to “get in on a pullback” will likely miss the boat. As wave three starts, the news is
probably still bearish, and most market players remain negative; but by wave three’s midpoint, “the crowd”
will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1
Wave 3 rally picks up steam and takes the top of Wave 1. As soon as the Wave 1 high is exceeded, the stops
are taken out. Depending on the number of stops, gaps are left open. Gaps are a good indication of a Wave 3 in
progress. After taking the stops out, the Wave 3 rally has caught the attention of traders

4.3 Wave 4

At the end of wave 4, more buying sets in and prices start to rally again. Wave four is typically clearly
corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than
38.2% of wave three. Volume is well below than that of wave three. This is a good place to buy a pull back if
you understand the potential ahead for wave 5. Still, fourth waves are often frustrating because of their lack of
progress in the larger trend.
4.4 Wave 5
Wave 5: In Elliott Wave Theory, wave five is the final leg in the direction of the dominant trend. The news is
almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally
buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum
indicators start to show divergences (prices reach a new high but the indicators do not reach a new peak). At
the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock
market during 2000 were received)
The wave 5 lacks huge enthusiasm and strength found in the wave 3 rally. Wave 5 advance is caused by a
small group of traders.Although the prices make a new high above the top of wave 3, the rate of power or
strength inside wave 5 advance is very small when compared to wave 3 advance

4.5 Wave A, B, and C

Wave A: Corrections are typically harder to identify than impulse moves. In wave A of a bear market, the
fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull
market. Some technical indicators that accompany wave A include increased volume, rising implied volatility
in the options markets and possibly a turn higher in open interest in related futures markets
Wave B: Prices reverse higher, which many see as a resumption of the now long-gone bull market. Those
familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders
reversal pattern. The volume during wave B should be lower than in wave A. By this point, fundamentals are
probably no longer improving, but they most likely have not yet turned negative
Wave C: Prices move impulsively lower in five waves. Volume picks up, and by the third leg of wave C,
almost everyone realizes that a bear market is firmly entrenched. Wave C is typically at least as large as wave
A and often extends to 1.618 times wave A or beyond

5) Corrective Waves
The classic definition of corrective waves is waves that move against the trend of one greater degree.
Corrective waves have a lot more variety and less clearly identifiable compared to impulse waves. Sometimes
it can be rather difficult to identify corrective patterns until they are completed. However, as we have
explained above, both trend and counter-trend can unfold in corrective pattern in today’s market, especially in
forex market. Corrective waves are probably better defined as waves that move in three, but never in five. Only
motive waves are fives.
There are five types of corrective patterns:
 • Zigzag (5-3-5)
 • Flat (3-3-5)
 • Triangle (3-3-3-3-3)
 • Double three: A combination of two corrective patterns above
 • Triple three: A combination of three corrective patterns above
5.1 Zigzag
Guidelines
 • Zigzag is a corrective 3 waves structure labelled as ABC
 • Subdivision of wave A and C is 5 waves, either impulse or diagonal
 • Wave B can be any corrective structure
 • Zigzag is a 5-3-5 structure
Fibonacci Ratio Relationship
 • Wave B = 50%, 61.8%, 76.4% or 85.4% of wave A
 • Wave C = 61.8%, 100%, or 123.6% of wave A
 • If wave C = 161.8% of wave A, wave C can be a wave 3 of a 5 waves impulse. Thus, one way
to label between ABC and impulse is whether the third swing has extension or not
5.2 Flat
A flat correction is a 3 waves corrective move labelled as ABC. Although the labelling is the same, flat differs
from zigzag in the subdivision of the wave A. Whereas Zigzag is a 5-3-5 structure, Flat is a 3-3-5 structure.
There are three different types of Flats: Regular, Irregular / Expanded, and Running Flats.

5.2.1 Regular Flats

Guidelines
 • A corrective 3 waves move labelled as ABC
 • Subdivision of wave A and B is in 3 waves
 • Subdivision of wave C is in 5 waves impulse / diagonal
 • Subdivision of wave A and B can be in any corrective 3 waves structure including zigzag, flat,
double three, triple three
 • Wave B terminates near the start of wave A
 • Wave C generally terminates slightly beyond the end of wave A
 • Wave C needs to have momentum divergence
Fibonacci Ratio Relationship
 • Wave B = 90% of wave A
 • Wave C = 61.8%, 100%, or 123.6% of wave AB
5.2.2 Expanded Flats
Guidelines
 • A corrective 3 waves move labelled as ABC
 • Subdivision of wave A and B is in 3 waves
 • Subdivision of wave C is in 5 waves impulse / diagonal
 • Subdivision of wave A and B can be in any corrective 3 waves structure including zigzag, flat,
double three, triple three
 • Wave B of the 3-3-5 pattern terminates beyond the starting level of wave A
 • Wave C ends substantially beyond the ending level of wave A
 • Wave C needs to have momentum divergence
Fibonacci Ratio Relationship
 • Wave B = 123.6% of wave A
 • Wave C = 123.6% – 161.8% of wave AB
5.2.3 Running Flats
Guidelines
 • A corrective 3 waves move labelled as ABC
 • Subdivision of wave A and B is in 3 waves
 • Subdivision of wave C is in 5 waves impulse / diagonal
 • Subdivision of wave A and B can be in any corrective 3 waves structure including zigzag, flat,
double three, triple three
 • Wave B of the 3-3-5 pattern terminates substantially beyond the starting level of wave A as in
an expanded flat
 • Wave C fails travel the full distance, falling short of the level where wave A ended
 • Wave C needs to have momentum divergence

Fibonacci Ratio Relationship

 • Wave B = 123.6% of wave A
 • Wave C = 61.8% – 100% of wave AB

5.3 Triangles
A triangle is a sideways movement that is associated with decreasing volume and volatility. Triangles have 5
sides and each side is subdivided in 3 waves hence forming 3-3-3-3-3 structure. There are 4 types of triangles
in Elliott Wave Theory: Ascending, descending, contracting, and expanding. They are illustrated in the graphic
below
Guidelines
 • Corrective structure labelled as ABCDE
 • Usually happens in wave B or wave 4
 • Subdivided into three (3-3-3-3-3)
 • RSI also needs to support the triangle in every time frame
 • Subdivision of ABCDE can be either abc, wxy, or flat
5.4 Double Three
Double three is a sideways combination of two corrective patterns. We’ve already looked at several corrective
patterns including zigzag, flat, and triangle. When two of these corrective patterns are combined together, we
get a double three. In addition,
Guidelines
 • A combination of two corrective structures labelled as WXY
 • Wave W and wave Y subdivision can be zigzag, flat, double three of smaller degree, or triple
three of smaller degree
 • Wave X can be any corrective structure
 • WXY is a 7 swing structure
Fibonacci Ratio Relationship
 • Wave X = 50%, 61.8%, 76.4%, or 85.4% of wave W
 • Wave Y = 61.8%, 100%, or 123.6% of wave W
 • Wave Y can not pass 161.8% of wave W
Below are examples of different combinations of two corrective structures which form the double threes:
5.5 Triple Three
Triple three is a sideways combination of three corrective patterns in Elliott Wave Theory
Guidelines
 • A combination of three corrective structures labelled as WXYXZ
 • Wave W, wave Y, and wave Z subdivision can be zigzag, flat, double three of smaller degree,
or triple three of smaller degree
 • Wave X can be any corrective structure
 • WXYZ is an 11 swing structure
Fibonacci Ratio Relationship in Elliott Wave Theory
 • Wave X = 50%, 61.8%, 76.4%, or 85.4% of wave W
 • Wave Z = 61.8%, 100%, or 123.6% of wave W
 • Wave Y can not pass 161.8% of wave W or it can become an impulsive wave 3
Below are examples of different combinations of three corrective structures which form the triple threes: