Elliott Wave

A theory that markets move in predictable patterns of five impulse waves (in the direction of the trend) followed by three corrective waves, based on recurring fractal structures driven by investor psychology.

Elliott Wave Theory was developed by Ralph Nelson Elliott in the 1930s. The core idea is that market prices move in recognizable patterns caused by the collective psychology of investors swinging between optimism and pessimism. The basic pattern is a five-wave impulse (three waves up separated by two corrective waves) followed by a three-wave correction (A-B-C). These patterns repeat at every degree of trend, from minutes to decades — a fractal structure.

In the five-wave impulse, waves 1, 3, and 5 move in the trend direction while waves 2 and 4 are corrections. Wave 3 is typically the longest and strongest. Specific rules govern the patterns: wave 2 cannot retrace more than 100% of wave 1, wave 3 cannot be the shortest of the three impulse waves, wave 4 cannot overlap wave 1's price territory. These rules make the theory falsifiable in principle.

Elliott Wave is among the most controversial tools in technical analysis. Proponents argue it provides a comprehensive framework for understanding market structure. Critics note that the wave labeling is highly subjective — experienced practitioners often disagree significantly on how to count the same chart. Predictions based on Elliott Wave have a mixed track record, and the theory is difficult to apply mechanically without significant interpretation. Most practitioners use it as a complement to other analysis rather than a standalone system.

This definition is for informational and educational purposes only. Nothing on Finance Compass constitutes financial, investment, or trading advice. Always conduct your own research and consult a qualified professional before making financial decisions.