Elliott Wave
Theory Guide
The complete guide to Elliott Wave Theory — from the 5-3 wave pattern to Fibonacci relationships, the 3 unbreakable rules, and how to apply wave analysis to real markets in 2026.
What is Elliott Wave Theory?
A method of technical analysis that identifies repeating wave patterns in price charts.
Elliott Wave Theory is one of the most enduring and debated concepts in technical analysis. Developed by Ralph Nelson Elliott in the 1930s, it proposes that financial market prices move in recognisable, repeating patterns he called "waves" — and that these waves are driven by the collective psychology of market participants.
Elliott was an accountant by trade. After being forced into retirement by illness, he spent years studying stock market price charts — painstakingly analysing 75 years of market data across yearly, monthly, weekly, daily, and even hourly timeframes. What he discovered was a remarkably consistent structure: markets do not move randomly. They move in patterns that reflect the emotional cycle of optimism, pessimism, fear, and greed.
"The Wave Principle is Ralph Nelson Elliott's discovery that social, or crowd, behaviour trends and reverses in recognisable patterns."— Robert Prechter, Elliott Wave Principle
In 1938, Elliott published his findings in a monograph titled The Wave Principle, and in 1946 he expanded the theory in Nature's Law — The Secret of the Universe. His central insight was deceptively simple: market movements are not random; they follow a natural rhythm governed by Fibonacci mathematics.
The basic structure consists of 5 waves in the direction of the main trend (impulse waves), followed by 3 waves against it (corrective waves). This 5-3 pattern repeats at every scale — from minute charts to multi-decade cycles — making wave theory fractal by nature. A Wave 1 on a weekly chart contains its own complete 5-3 wave structure on the daily chart, and so on down to the smallest observable timeframe.
This fractal property is what makes Elliott Wave Theory so powerful — and so difficult to master. The same principles apply whether you are analysing a 5-minute chart or a 50-year price history. The challenge lies in correctly identifying where you are within the larger wave structure.
Nearly a century after its discovery, Elliott Wave Theory remains widely used by institutional and retail traders alike. Not because it is a crystal ball — it is not — but because it provides a structured framework for understanding market behaviour that no purely mathematical indicator can replicate.
The Basic 5-3 Wave Pattern
5
/\
/ \ B
/ \ /\
3 X \
/\ A C
/ \
/ 4
1
\ /
\ /
2 5 impulse waves (1-2-3-4-5) followed by 3 corrective waves (A-B-C)
Impulse Wave Structure
Impulse waves move in the direction of the main trend. Waves 1, 3, and 5 are motive; waves 2 and 4 are corrective.
Wave 1
The initial move in the direction of the new trend. Often goes unnoticed by most traders. A small group of investors start buying, sensing a shift in the underlying fundamentals.
- Usually the shortest impulse wave
- Often occurs during peak pessimism
- Low volume, hesitant start
Wave 2
A corrective move against Wave 1, never retracing more than 100% of Wave 1. This wave tests the conviction of early bulls and shakes out weak hands.
- Retraces 50–78.6% of Wave 1
- Cannot go below Wave 1's starting point
- Often a sharp, sudden decline
Wave 3
The most powerful wave, never the shortest. Strong momentum builds as the trend becomes obvious to the broader market. This is where the majority of profits are made.
- Usually the longest wave
- High volume confirmation
- Breakouts through resistance
- 1.618x Wave 1 is common target
Wave 4
A corrective wave that prepares for the final push. It cannot overlap with Wave 1's territory — this is one of the three unbreakable rules.
- Often sideways consolidation
- Less sharp than Wave 2
- May form triangles or flats
- Cannot enter Wave 1 price territory
Wave 5
The final move of the impulse. Often driven by retail traders joining late. May show divergence with momentum indicators, signalling the trend is nearing exhaustion.
- Equal to or 61.8% of Wave 1
- Momentum divergence common
- Volume often lower than Wave 3
- Euphoria in uptrends, despair in downtrends
Corrective Wave Structure
After the 5-wave impulse, a 3-wave correction follows against the main trend.
Wave A
The first leg of the correction against the main trend. Many traders see this as a pullback to buy — and most are wrong.
- Often mistaken for a dip
- Sharp decline from Wave 5
- Volume starts to increase
Wave B
A counter-trend rally within the correction. Traps traders who think the trend is resuming. It is the classic bull trap in a downtrend.
- Bull trap in downtrends
- Usually weaker than Wave A
- Lower volume
- Can nearly reach Wave 5 highs
Wave C
The final corrective wave. Often extends to 1.618x Wave A. This is where capitulation happens and the previous trend is fully unwound.
- Usually equals Wave A in length
- Can extend to 1.618x Wave A
- High volume, panic selling/buying
- Completes the correction
Fibonacci Relationships in Elliott Wave Theory
Elliott waves are closely tied to Fibonacci ratios. Use these relationships to project wave targets and validate your wave counts.
| Wave | Typical Relationship | Note |
|---|---|---|
| Wave 2 | 50% – 78.6% of Wave 1 | Must not exceed 100% |
| Wave 3 | 1.618x – 2.618x Wave 1 | Never the shortest |
| Wave 4 | 38.2% – 50% of Wave 3 | Cannot enter Wave 1 territory |
| Wave 5 | Equal to Wave 1 or 0.618x Wave 1 | May extend to 1.618x Wave 1 |
| Wave C | Equal to Wave A or 1.618x Wave A | Often extends in strong corrections |
The 3 Unbreakable Rules
Breaking a rule means your wave count is wrong. No exceptions.
Wave 2 Cannot Retrace Beyond Wave 1's Start
If Wave 2 breaks below Wave 1's starting point, your wave count is wrong. This is absolute — no exceptions.
Wave 3 Is Never the Shortest
Wave 3 must be longer than at least one of the other impulse waves (1 or 5). In practice, it is almost always the longest.
Wave 4 Cannot Enter Wave 1 Territory
In an uptrend, Wave 4's low cannot overlap with Wave 1's high. No overlap allowed — period.
Guidelines (Not Rules)
These are strong tendencies, not absolutes. They help you anticipate wave behaviour and validate your analysis.
Alternation
If Wave 2 is sharp, Wave 4 tends to be sideways (and vice versa). This helps you anticipate the character of corrections.
Wave 3 Volume
Volume should be highest during Wave 3, confirming the trend strength. If volume is weak during Wave 3, re-examine your count.
Fifth Wave Divergence
RSI often shows bearish divergence at Wave 5 tops (higher price, lower RSI). This is one of the most reliable early warning signals.
Channel Lines
Waves 2 and 4 bottoms can be connected to form a channel. Wave 3 often exceeds the upper line, confirming its strength.
Trading with Elliott Wave Theory
How to use wave analysis for entries, exits, stop losses, and trend reversals.
Entry Points
Enter at the start of Wave 3 (after Wave 2 correction) or Wave 5 (after Wave 4 correction). Wave 3 entries have the best risk/reward ratio.
Profit Targets
Use Fibonacci extensions to project wave targets. Wave 3 often reaches 1.618x Wave 1. Wave 5 often equals Wave 1.
Stop Loss Placement
Place stops just below Wave 2 low when entering Wave 3, or below Wave 4 low when entering Wave 5.
Trend Reversal Signals
After a 5-wave impulse, expect a 3-wave correction. Use ABC patterns to identify the end of corrections and the start of a new trend.
Combining Elliott Wave with Other Methods
Wave theory is most powerful when combined with other forms of analysis.
Elliott Wave Theory should never be used in isolation. The most successful wave analysts combine it with other technical and fundamental tools to increase the probability of correct wave counts and profitable trades.
Fibonacci Retracements & Extensions
Fibonacci levels are the natural companion to Elliott Wave Theory. Use retracements (38.2%, 50%, 61.8%, 78.6%) to identify where corrective waves are likely to end, and extensions (1.618x, 2.618x) to project impulse wave targets. When a Fibonacci level aligns with your expected wave completion point, the probability of a reversal increases significantly.
RSI Divergence
The Relative Strength Index is particularly useful for confirming Wave 5 completions. When price makes a new high in Wave 5 but RSI shows a lower high (bearish divergence), it signals that momentum is fading and the impulse is nearing exhaustion. This divergence pattern is one of the most reliable signals in wave analysis.
Support & Resistance Levels
Horizontal support and resistance levels provide additional confirmation for wave targets. If your Elliott Wave count suggests Wave 3 should end near 1.1800, and there is also a strong horizontal resistance level at 1.1800, that confluence makes the level far more significant. Always map key levels before you start counting waves.
Volume Analysis
Volume is the ultimate confirmation tool. In a valid impulse wave, volume should increase during waves 1, 3, and 5, and decrease during waves 2 and 4. Wave 3 should show the highest volume. If your Wave 3 has lower volume than Wave 1, your count is likely wrong.
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Frequently Asked Questions
What is Elliott Wave Theory?
Elliott Wave Theory is a method of technical analysis that identifies repeating wave patterns in financial market prices. Developed by Ralph Nelson Elliott in the 1930s, it proposes that market prices move in predictable patterns called "waves" driven by collective investor psychology. The basic structure is a 5-wave impulse in the trend direction followed by a 3-wave correction — the 5-3 pattern.
Is Elliott Wave Theory reliable?
Elliott Wave Theory provides a framework for understanding market structure, but it is subjective and open to interpretation. Two analysts can see different wave counts on the same chart. It works best when combined with other analysis methods like Fibonacci retracements, RSI divergence, and support/resistance levels. It should never be used as your only trading tool.
How do I know which wave I'm in?
This is the hardest part of Elliott Wave analysis. Use the three unbreakable rules to eliminate invalid counts. Look at volume patterns, momentum divergence, and Fibonacci retracements for clues. Wave 3 typically has the highest volume, Wave 5 often shows RSI divergence. Practice identifying completed patterns on historical charts before trading live.
What timeframe works best for Elliott Wave Theory?
Elliott Wave Theory is fractal — patterns exist on all timeframes from 1-minute charts to multi-decade cycles. Higher timeframes (Daily, Weekly) give clearer, more reliable patterns but fewer trading opportunities. Lower timeframes (1H, 4H) have more noise and more false counts. Start with 4H or Daily charts to learn, then zoom into lower timeframes for precise entries.
Can I use Elliott Wave Theory for day trading?
Yes, but it is more challenging on lower timeframes due to increased market noise. Day traders typically identify wave structure on 1H charts, then drop to 15-minute or 5-minute charts for entries. The key is always aligning your lower timeframe counts with the higher timeframe wave structure.
What is the difference between Elliott Wave Theory and Fibonacci analysis?
They are closely related but distinct. Elliott Wave Theory identifies the wave structure (the 5-3 pattern), while Fibonacci analysis provides the mathematical ratios used to project wave targets and validate counts. Most Elliott Wave practitioners use Fibonacci retracements (38.2%, 50%, 61.8%, 78.6%) and extensions (1.618x, 2.618x) as essential tools within their wave analysis.
Do I need special software for Elliott Wave analysis?
No. Any charting platform with trend lines and Fibonacci tools works. TradingView has dedicated Elliott Wave drawing tools built in. MetaTrader 4 and MetaTrader 5 have similar capabilities. The analysis is manual — there is no reliable automated wave counting software that outperforms a skilled analyst.
What are the 3 rules of Elliott Wave Theory?
The three unbreakable rules are: (1) Wave 2 cannot retrace beyond the starting point of Wave 1, (2) Wave 3 is never the shortest impulse wave, and (3) Wave 4 cannot overlap with the price territory of Wave 1. If any of these rules are violated, your wave count is wrong and needs to be revised.
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