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Based on Elliott's Wave Theory, market prices will alternate between an impulsive phase and a corrective phase. 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.

If a trader sees a stock moving upward on an impulse wave, they may go long until it completes its fifth wave. Anticipating a reversal, the trader may then go short on the stock. Underlying this trading theory is the idea that fractal patterns recur in financial markets. In mathematics, fractal patterns repeat themselves on an infinite scale.

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The Elliott wave principle, or Elliott wave theory, is a form of technical analysis that finance traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology and price levels, such as highs and lows, by looking for patterns in prices.

The Elliott wave principle posits that collective trader psychology, a form of crowd psychology, moves between optimism and pessimism in repeating sequences of intensity and duration. These mood swings create patterns in the price movements of markets at every degree of trend or time scale.

The Elliott wave principle states that markets grow from small price movements by linking Elliot wave patterns to form larger five-wave and three-wave structures that exhibit self-similarity, applicable on all timescales. Each level of such timescales is called the degree of the wave, or price pattern. Each degree of waves consists of one full cycle of motive and corrective waves. Waves 1, 3, and 5 of each cycle are motive in character, while waves 2 and 4 are corrective. The majority of motive waves assure forward progress in the direction of the prevailing trend, in bull or bear markets, but yielding an overall principle of growth of a market.

The overall movement of a wave one degree higher is upward in a bullish trend. After the initial five waves forward and three waves of correction, the sequence is repeated on a larger degree and the self-similar fractal geometry continues to unfold. The completed motive pattern comprises 89 waves, followed by a completed corrective pattern of 55 waves.[3]

Each degree of a pattern in a financial market has a name. Practitioners use symbols for each wave to indicate both function and degree. Numbers are used for motive waves, and letters for corrective waves (shown in the highest of the three idealized series of wave structures or degrees). Degrees are not strictly defined by absolute size or duration, but by form. Waves of the same degree may be of very different size or duration.[3]

Elliott wave analysts (or Elliotticians) hold that each individual wave has its own signature or characteristic, which typically reflects the psychology of the moment.[3][4] Understanding those personalities is key to the application of the Wave Principle; they are defined below. (Definitions assume a bull market in equities; the characteristics apply in reverse in bear markets.)

Elliott's market model relies heavily on looking at price charts. Practitioners study developing trends to distinguish the waves and wave structures, and discern what prices may do next; thus the application of the Wave Principle is a form of pattern recognition.

The structures Elliott described meet the common definition of a fractal (self-similar patterns appearing at every degree of trend).[citation needed] Elliott wave practitioners argue that just as naturally occurring fractals often expand and grow more complex over time, the model shows that collective human psychology develops in natural patterns, via buying and selling decisions reflected in market prices: "It's as though we are somehow programmed by mathematics. Seashell, galaxy, snowflake or human: we're all bound by the same order."[5] Critics, however, argue it is a form of pareidolia.

A common guideline called "alternation" observes that in a five-wave pattern, waves 2 and 4 often take alternate forms; a simple sharp move in wave 2, for example, suggests a complex mild move in wave 4. Alternation can occur in impulsive and corrective waves. Elliott observed that alternate waves of the same degree must be distinctive and unique in price, time, severity, and construction. All formations can guide influences on market action. The time period covered by each formation, however, is the major deciding factor in the full manifestation of the Rule of Alternation. A sharp counter-trend correction in wave 2 covers a short distance in horizontal units. This should produce a sideways counter-trend correction in wave 4, covering a longer distance in horizontal units, and vice versa. Alternation provides analysts a notice of what not to expect when analyzing wave formations.

Corrective wave patterns unfold in forms known as zigzags, flats, or triangles. In turn these corrective patterns can come together to form more complex corrections.[4] Similarly, a triangular corrective pattern is formed usually in wave 4, but very rarely in wave 2, and is the indication of the end of a correction.[6]

R. N. Elliott's analysis of the mathematical properties of waves and patterns eventually led him to conclude that "The Fibonacci Summation Series is the basis of The Wave Principle".[1] Numbers from the Fibonacci sequence surface repeatedly in Elliott wave structures, including motive waves (1, 3, 5), a single full cycle (8 waves), and the completed motive (89 waves) and corrective (55 waves) patterns. Elliott developed his market model before he realized that it reflects the Fibonacci sequence. "When I discovered The Wave Principle action of market trends, I had never heard of either the Fibonacci Series or the Pythagorean Diagram".[1]

The Fibonacci sequence is also closely connected to the Golden ratio (1.618). Practitioners commonly use this ratio and related ratios to establish support and resistance levels for market waves, namely the price points which help define the parameters of a trend.[7] See Fibonacci retracement.

Hamilton Bolton, founder of The Bank Credit Analyst, espoused wave analysis to a wide readership in the 1950s and 1960s in his annual market commentaries and forecasts. He also wrote the book The Elliott Wave Principle of Stock Market Behavior.[citation needed]

Bolton introduced the wave principle to A.J. Frost (1908-1999), who provided weekly financial commentary on the Financial News Network in the 1980s. Over the course of his lifetime Frost's contributions to the field were of great significance and today the Canadian Society of Technical Analysts awards the A.J. Frost Memorial Award to someone each year who has also made a significant contribution to the field of technical analysis.[citation needed]

Benoit Mandelbrot, who developed mathematical models of market pricing based on fractal geometry, expressed caution about the validity of wave models: .mw-parser-output .templatequote{overflow:hidden;margin:1em 0;padding:0 40px}.mw-parser-output .templatequote .templatequotecite{line-height:1.5em;text-align:left;padding-left:1.6em;margin-top:0}

Critics warn the Wave Principle is too vague to be useful since practitioners cannot consistently identify the beginning or end of waves, resulting in forecasts prone to subjective revisions. Technical analyst David Aronson wrote:[14]

The Elliott wave principle, as popularly practiced, is not a legitimate theory, but a story, and a compelling one that is eloquently told by Robert Prechter. The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method's loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.

Elliott wave was an incredible discovery for its time. But, as technologies, governments, economies, and social systems have changed, the behavior of people has also. These changes have affected the wave patterns R.N. Elliott discovered. Consequently, strict application of orthodox Elliott wave concepts to current day markets skews forecasting accuracy. Markets have evolved, but Elliott has not.[15]

Elliott found that corrective waves retrace impulse waves in Fibonacci proportions of 38%, 50%, and 62%. He also found that impulse waves within a larger impulse sequence relate to each other in Fibonacci proportion."}},{"@type": "Question","name": "What Are the Disadvantages of Elliott Wave?","acceptedAnswer": {"@type": "Answer","text": "While it is possible to identify patterns in the movement of stock prices, that certainly is no guarantee that anyone can predict where a stock price will land tomorrow or next week or next month."}},{"@type": "Question","name": "How Do You Study Elliott Wave?","acceptedAnswer": {"@type": "Answer","text": "Studying the Elliott Wave Theory is about human psychology more than it is about studying specific market data. Bob Prechter, who founded Elliott Wave International, said it is about studying the way crowds behave as it relates to buying and selling stocks."}}]}]}] Investing Stocks Bonds ETFs Options and Derivatives Commodities Trading FinTech and Automated Investing Brokers Fundamental Analysis Technical Analysis Markets View All Simulator Login / Portfolio Trade Research My Games Leaderboard Banking Savings Accounts Certificates of Deposit (CDs) Money Market Accounts Checking Accounts View All Personal Finance Budgeting and Saving Personal Loans Insurance Mortgages Credit and Debt Student Loans Taxes Credit Cards Financial Literacy Retirement View All News Markets Companies Earnings CD Rates Mortgage Rates Economy Government Crypto ETFs Personal Finance View All Reviews Best Online Brokers Best Savings Rates Best CD Rates Best Life Insurance Best Personal Loans Best Mortgage Rates Best Money Market Accounts Best Auto Loan Rates Best Credit Repair Companies Best Credit Cards View All Academy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All TradeSearchSearchPlease fill out this field.SearchSearchPlease fill out this field.InvestingInvesting Stocks Bonds ETFs Options and Derivatives Commodities Trading FinTech and Automated Investing Brokers Fundamental Analysis Technical Analysis Markets View All SimulatorSimulator Login / Portfolio Trade Research My Games Leaderboard BankingBanking Savings Accounts Certificates of Deposit (CDs) Money Market Accounts Checking Accounts View All Personal FinancePersonal Finance Budgeting and Saving Personal Loans Insurance Mortgages Credit and Debt Student Loans Taxes Credit Cards Financial Literacy Retirement View All NewsNews Markets Companies Earnings CD Rates Mortgage Rates Economy Government Crypto ETFs Personal Finance View All ReviewsReviews Best Online Brokers Best Savings Rates Best CD Rates Best Life Insurance Best Personal Loans Best Mortgage Rates Best Money Market Accounts Best Auto Loan Rates Best Credit Repair Companies Best Credit Cards View All AcademyAcademy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All EconomyEconomy Government and Policy Monetary Policy Fiscal Policy Economics View All Financial Terms Newsletter About Us Follow Us Table of ContentsExpandTable of ContentsWavesPredictions Based on Wave PatternsTheory InterpretationWave DegreesTheory's PopularityFAQsThe Bottom LineTechnical AnalysisAdvanced Technical Analysis ConceptsIntroduction to Elliott Wave TheoryBy e24fc04721