The Elliott Wave Principle is primarily a school of technical analysis that follows trends and describes market movements as waves. In Elliot Wave theory, each market movement, or wave pattern, is designated with a numerical label and a behavioral designation: impulsive (trend) or reactive (corrective). It is named after the market analyst RN Elliott, who published his ideas in two books: The Wave Principle (1938) and Nature’s Laws-The Secret of the Universe (1946). Elliott wrote that a market move, whether a move up or down, can always be divided into five separate waves, with three being impulsive or trending moves and two corrective or counter-trending moves. The two corrective waves separated the three trend waves.

The trend waves themselves could be divided into five smaller waves of the same sequence as the overall move, and corrective waves often met predictable retracements and divided into three waves: two impulsive waves separated by a corrective one.

Elliott believed that the series of Fibonacci sums was the basis of his wave pattern. He theorized that it is mass psychology that drives markets, and since that was nothing more than the collective actions of individuals and since individuals, like all living things, are rhythmic, their actions can be predicted. He also proposed that there are waves within waves, with each smaller time frame mimicking the larger formation, a phenomenon we now know as fractal geometry.

According to his detractors, one of the drawbacks of Elliot’s theories is that they are too subjective, and analysts need to regularly update and adjust their wave counts as the market moves. “Ellioticians” seem to say that the direction of the market is predetermined, but then they adjust their wave counts when the market doesn’t work the way they had programmed.

We think trader and market forecaster Cynthia Kase summed it up best in her 1996 book Trading with the Odds: “Elliott’s theories about the market in general and his view that there is a natural law governing the market are correct in terms The fact that traders like Kase, along with Bill Williams and Justine Williams-Lara, the traders and authors of the Trading Chaos trilogy of books, continue to use wave counting in their trading also lends credence to wave counting theories. Elliott.

My description of the Elliott Wave here is relatively short considering the weight the theory holds for many professional traders. Elliott Wave theory and the observations and use of Fibonacci numbers were groundbreaking, and there is no shortage of excellent descriptions of how his theories are applied in today’s marketplace, including the work of Kase.