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Elliott Wave

The theory that markets move in repeating waves: five with the trend, three against it. Here is the basic model, the labelling rules, and where the theory helps and where it turns into endless relabelling.

Way to Lambo · 6 min read · level: intermediate

Contents
  1. The core idea
  2. The character of each wave
  3. Labelling rules
  4. How to use it in practice
  5. Common mistakes

In short

Impulse
Five waves with the trend: 1, 3 and 5 are moves, 2 and 4 are pullbacks.
Correction
Three waves against the trend: A, B, C.
Key rules
Wave 2 doesn't go below the start of wave 1, wave 3 isn't the shortest, wave 4 doesn't enter wave 1's territory.
Weak spot
Labelling is subjective: the same chart can be labelled several ways.

The core idea

Ralph Elliott noticed that markets don't move randomly but in waves that reflect shifts in crowd mood: optimism, doubt, optimism again. The basic model is an eight-wave cycle: five in the direction of the trend (the impulse) and three against it (the correction).

Five impulse waves and an A–B–C correction012345ABCcorrection A–B–Cimpulse 1–5
An impulse 1–2–3–4–5 and an A–B–C correction. Illustrative data.

The character of each wave

  • Wave 1 — the first move, which most people mistake for a bounce in the old trend.
  • Wave 2 — a deep pullback; many are sure the trend hasn't changed.
  • Wave 3 — the strongest and longest: everyone notices the trend and big money joins.
  • Wave 4 — a sideways, sluggish correction; profit-taking.
  • Wave 5 — the final push on crowd emotion, often with a divergence on oscillators.
  • A–B–C — a correction of the whole impulse: a drop, a trap bounce, another drop.

Labelling rules

01
Wave 2 never goes beyond the start of wave 1
If it does, the labelling is wrong.
02
Wave 3 is never the shortest
Of waves 1, 3 and 5.
03
Wave 4 doesn't enter wave 1's price territory
For a standard impulse.
04
Use Fibonacci
Wave 2 often retraces 50–61.8% of wave 1; wave 3 often equals 1.618 of wave 1.

How to use it in practice

The most practical use is trading wave 3. It starts where the wave 2 pullback ends, usually in the 0.5–0.618 Fibonacci zone. Stop beyond the start of wave 1: if price goes there, the count is broken.

Waves are easy to label after the fact and hard to label in real time. If you keep relabelling the chart to make it "fit", the theory has stopped helping. Use it as a map of market phases, not as a precise forecast.

Common mistakes

Breaking the basic rules

If wave 4 enters wave 1's territory, it's not a "special case" but a wrong count.

Fading the fifth wave

A fifth wave can extend much further than expected.

Labelling every wiggle

Waves within waves go on forever. Work with one or two degrees of scale.

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