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Elliott Wave Theory (EWT), developed by Ralph Nelson Elliott, is a method of technical analysis that explains how financial markets move in repetitive patterns driven by collective human psychology. It is based on the idea that market participants react in predictable ways to optimism, fear, and uncertainty, creating recognizable price structures.
According to EWT, a complete market cycle consists of two phases: the impulse phase and the corrective phase. The impulse phase includes five waves (labeled 1–2–3–4–5) that move in the direction of the main trend. Wave 1 begins the trend, Wave 2 retraces part of it, Wave 3 is typically the strongest and most extended move, Wave 4 is a smaller correction, and Wave 5 represents the final push of the trend.
After the impulse phase, the market enters a corrective phase consisting of three waves (A–B–C) that move against the prevailing trend. These corrections help reset the market before the next major move begins.
EWT follows three key rules: Wave 2 never retraces 100% of Wave 1, Wave 3 is never the shortest wave, and Wave 4 does not overlap the price territory of Wave 1 in a standard impulse structure. These rules help maintain structural integrity and guide wave identification.
Fibonacci ratios play a crucial role in EWT, helping traders estimate retracement and extension levels for different waves. In practical trading, Wave 3 offers the highest probability opportunity due to strong momentum, while Wave 5 signals a mature trend with higher risk.
Overall, Elliott Wave Theory provides a structured framework to understand market behavior, identify trends, and make probability-based trading decisions rather than relying on random price movements.