Elliott Wave Theory

Elliott Wave Principle is a technical analysis named after Ralph Nelson Elliott that investors use to forecast trends in the financial markets by identifying extremes in investor psychology, highs and lows in prices, and other collective activities.

Based on rhythms found in nature, the theory suggests that the market moves up in a series of five waves and down in a series of three waves. Elliott's market model relies heavily on 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.

A correct Elliott wave "count" must observe three rules: 1) Wave 2 always retraces less than 100% of wave 1; 2) Wave 3 cannot be the shortest of the three impulse waves, namely waves 1, 3 and 5; 3) Wave 4 does not overlap with the price territory of wave 1, except in the rare case of a diagonal triangle. A common guideline observes that in a five-wave pattern, waves 2 and 4 will often take alternate forms; a sharp move in wave 2, for example, will suggest a mild move in wave 4. Corrective wave patterns unfold in forms known as zigzags, flats, or triangles.