Loading the player...

What is the 'Elliott Wave Theory'

The Elliott Wave Theory was developed by Ralph Nelson Elliott to predict price movements by observing and identifying repetitive wave patterns. 

BREAKING DOWN 'Elliott Wave Theory'

The Elliott Wave Theory was developed by Ralph Nelson Elliott in the 1930s. After being forced into retirement due to an illness, Elliott needed something to occupy his time and began studying 75 years worth of yearly, monthly, weekly, daily, hourly, and 30-minute charts across various indexes. The theory gained notoriety in 1935 when Elliott made an uncanny prediction of a stock market bottom and has since become a staple for thousands of portfolio managers, traders, and private investors.

R.N. Elliott came up with very specific rules governing how to identify and capitalize on these wave patterns. These books, articles, and letters are covered in R.N. Elliott's Masterworks, which was eventually published in 1994. Elliott Wave International was also formed as the largest independent financial analysis and market forecasting firm in the world with publications featuring labeled charts, unique insights, and educational products.

R.N. Elliott was careful to note that these patterns aren't designed to provide any kind of certainty about future price movement, but rather, the probability of a future direction in the market. In other words, they should be used in conjunction with other forms of technical analysis, including technical indicators and chart patterns, to identify more specific opportunities. The subjectivity of the theory also means that traders may have differing opinions of how Elliott Wave Theory applies to a given security at a given point in time.

How Elliott Waves Work

Elliott Waves Theory consists of impulse and corrective waves at its core:

  • Impulse Waves - Impulse waves consist of five sub-waves moving in the same direction as the trend of the next largest size.
  • Corrective Waves - Corrective waves consist of three sub-waves moving in the opposite direction as the trend of the next largest size.

These impulse and corrective waves are nested to create larger patterns. For example, a one-year chart may be in the midst of a corrective wave, but a 30-minute chart may show an impulse wave. A trader might interpret this as a long-term bearish outlook with a short-term bullish outlook.

Fibonacci ratios, such as 35%, 50%, and 62%, are used to determine the magnitude of these waves. For example, a corrective wave may have a drawdown of 35% before becoming an impulse wave. R.N. Elliott stressed the importance of using Fibonacci ratios in combination with his Elliott Wave Theory in order to maximize the probability of success.

Elliott Wave Oscillator Chart

Several other indicators were also developed based on the Elliott Wave Theory, including the Elliott Wave Oscillator, which is pictured in the image above. The oscillator provides an easier to use method of predicting future price direction based on the Elliott Wave Principles.

  1. Corrective Waves

    Corrective waves are a set of stock price movements associated ...
  2. Wolfe Wave

    In technical analysis, it is a naturally occurring trading pattern ...
  3. Technical Correction

    A technical correction is a decrease in the market price of an ...
  4. Refinance Wave

    A Refinance Wave is a phenomenon in which a spike in mortgage ...
  5. Pattern

    In technical analysis, the distinctive formation created by the ...
  6. Market Segmentation Theory

    Market segmentation theory posits that there is no relationship ...
Related Articles
  1. Trading

    Introduction to Elliott Wave Theory

    Acquaint yourself with Elliott Wave Theory, the principle built on the discovery that stock markets did not behave in a chaotic manner.
  2. Trading

    Elliott Wave In The 21st Century

    Discover new developments that help you apply this difficult theory to trading and how computer power can help reduce the guess-work.
  3. Investing

    Hess Corporation: An Activist Investment Analysis (HES)

    Learn about Elliott Management's 2013 activist investor involvement with Hess Corporation. Find out what the hedge fund changed about Hess's management.
  4. Investing

    Singer: 'The Biggest Bond Bubble in World History'

    When yields are nothing or negative, bonds aren't a "safe haven," says Elliott Management. The fallout could be "surprising, sudden, intense, and large."
  5. Trading

    Bank of America Rally Could Accelerate in 2018

    Bank of America stock has mounted a long-term Fibonacci retracement level, opening the door to more rapid upside into 2018.
  6. Investing

    Paul Singer Moves Against the Trend, Buys Apple

    Many investors were selling off Apple shares, but Singer's Elliott Management was buying them up.
  7. Investing

    Elliott Management to Reject GE's Offer

    The activist investor has announced its plans to reject a tender offer from GE for SLM.
  8. Trading

    Can Tesla Stock Hold $300?

    Tesla has seen a string of bearish news and could break down, offering a buying opportunity at April breakout support near $275.
  9. Trading

    Gold Uptrend In Jeopardy After Selloff (GLD)

    Gold's high volume breakaway gap predicts much lower prices in coming weeks.
  1. Why is the Fibonacci Retracement important for traders and analysts?

    Find out why traders and analysts in financial markets use Fibonacci retracement to help identify support and resistance ... Read Answer >>
  2. What is Fibonacci retracement, and where do its ratios come from?

    A Fibonacci retracement is a popular tool that can be used to identify support and resistance levels, and place stop-loss ... Read Answer >>
  3. How can I determine a stock's next resistance level or target price?

    Determining where the price of an asset will stop once it has hit a new high is one of the most difficult tasks for any trader. Read Answer >>
  4. What Does It Mean When There Is 'Price Action'?

    Price action refers to the day-to-day fluctuation in the price of an asset. Read Answer >>
  5. What are the differences between a bar chart and candle sticks?

    Explore the difference between bar and candlestick charts. Learn how technical analysts use charts in the analysis of supply ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center