Elliott Waves

Understanding Elliott Waves

Elliott Waves refer to a theory developed by Ralph Nelson Elliott in the 1930s, which has become an essential tool for stock and crypto market traders.

The theory is based on Elliott’s observation of recurring fractal wave patterns and aims to describe price movements in financial markets by examining persistent changes in investor sentiment and psychology.

Elliott Waves Theory
Elliott Waves Theory | Source: Investopedia

Elliott’s Discovery of Wave Patterns in Financial Markets

Elliott discovered that stock markets, previously believed to behave randomly, actually traded in repetitive patterns called waves.

These patterns closely mirrored the recurring fractal patterns found in financial markets and were linked to mass swings in investor psychology.

Traders often metaphorically describe their actions as “riding a wave” when attempting to identify market trends.

Elliott Wave Theory’s Fractal Nature

While the Elliott Wave Theory shares similarities with the Dow Theory, which recognizes that stock prices move in waves, Elliott’s contribution was recognizing the fractal element within these patterns.

By breaking down and studying these patterns in detail, Elliott identified their fractal nature, indicating their infinite repetition on ever-smaller scales.

Impulse and Corrective Waves in Elliott Wave Theory

According to the theory, there are various types of waves.

An impulse wave aligns with the overall trend and consists of five waves in its pattern. In contrast, a corrective wave moves in the opposite direction.

This pattern repeats itself infinitely on decreasing scales, demonstrating its fractal nature.