Elliott Wave Theory: Reading Market Psychology

Core Idea

Markets move in repeating fractal patterns of five impulsive waves followed by three corrective waves — reflecting shifts in mass psychology from optimism to pessimism.

The Basic Pattern

• Impulse (with trend): 5 waves labeled 1-2-3-4-5.
• Waves 1, 3, 5 = motive (in trend direction)
• Waves 2, 4 = corrective retracements
• Correction (against trend): 3 waves labeled A-B-C.

Rules (Non-negotiable)

1. Wave 2 never retraces >100% of wave 1.
2. Wave 3 is never the shortest of waves 1/3/5.
3. Wave 4 never overlaps wave 1 territory.

Guidelines

• Wave 3 is usually the strongest (1.618× wave 1 is common — Fibonacci).
• Wave 2 often retraces 50–61.8% of wave 1.
• Alternation: If wave 2 is sharp, wave 4 is usually flat, and vice versa.

Fractal Nature

Elliott waves exist at every timeframe — a 5-wave impulse on the daily contains 5-wave impulses on the hourly, and so on.

Application

• Identifying trend endings (wave 5 exhaustion + divergence).
• Setting Fibonacci-based targets and stops.
• Not a standalone system — combine with volume, MACD divergence, and support/resistance.