Elliott wave theory

Elliott wave theory is developed by Ralph Nelson Elliott in 1930s, based on the idea that market moves in fractal nature. Fractal nature means market makes similar patterns in smaller as well as in larger time frame in its repetitive nature of mass trading psychology, which can be predictable with greater efficiency.

Elliott wave pattern is further classified in Motive and Corrective waves. Motive wave moves in the direction of major trend, while corrective wave moves against the major trend, which corrects it.

As shown in figure, up cycle shown as motive wave, while down cycle shown as its corrective wave. Motive wave moves in 5 waves, while corrective wave moves in 3 waves in its opposite direction. 1 wave of motive wave in smaller time frame should again divide in 5 wave move, which describes its fractal nature. Similarly 2 wave down in smaller time frame should divide in 3 wave a-b-c movement in correction.

The following guideline should be followed by motive or corrective wave to qualify as prescribed waves as per Elliott wave theory.

1. Wave 2 can’t retrace more than beginning of wave 1. 

2. Wave 3 can not be shortest wave of all three impulse wave 1, 3 and 5.

3. Wave 4 doesn’t overlap with price territory of wave 1.  [Except only in case of leading ( as wave 1) or ending ( as wave 5) diagonal wave]

In corrective pattern there are four subcategories. 1. zigzag, 2. flat, 3. triangle and 4. complex correction (combined of previous three patterns).

Wave theory involves the Fibonacci series and golden ratio, which is normally involve in anything which is going to start progressing and decaying with time. Usually 0.618, 1.618, 0.236, 0.382, 0.5, 0.784 and 2.618 are the Fibonacci ratio widely useful in predicting wave targets compared to previous cycle wave.