Elliot Waves are a way of approaching the market using technical analysis, and what lies behind technical analysis, the psychology of the masses: what they think and how they can behave.
Ralph Nelson Elliott was the creator of the theory that bears his name, the Elliot Wave principle.
To understand how Mr. Elliott came to develop his theory, you have to know a little about his history. Ralph Nelson Elliott was an accountant with a very good reputation in his time, who decided to start his own consulting business, but shortly after an illness contracted during his stays outside the United States began, it forced him to retire from work.
For five years Elliott has a hard time, his health is very poor and he is about to die. In his convalescence, Elliott decides to study the stock market to keep his mind occupied.
It uses the historical charts of the Dow Jones, taking 75 years of quotes for its studies and studying all the temporalities, annual, monthly, weekly, daily, hourly and 30-minute charts.
From all this study, Elliott proves that markets move in different types of waves, caused as I said before, by investors' feelings. This is the origin of the Elliot Wave Theory.

The principle of Elliot Waves

According to Elliott, all market movements follow a repetitive rhythm of five waves in the direction of the main trend, and three corrective waves.
The advancing waves are 1, 2, 3, 4, 5, being impulsive waves, 1, 3 and 5, while 2 and 4 are corrective waves.
After the 5-wave advance is completed, a 3-wave corrective process, a, b, and c, begins.
Waves a and c move in the direction of the correction, while wave b moves in the direction of the previous trend.
All of these waves can, in turn, belong to larger waves, which would explain much larger movements.

Bearish and bullish Elliot waves

Waves in the direction of the trend are called impulsive, and numbers are usually used to classify them, those that go against the trend are corrective, and letters are used.
Elliott used Fibonacci numbers to decide how far a wave can extend, or how far it can correct.

Elliot Wave Counter

An Elliott Wave trader must have a good grasp of the theory of wave formation, in order to be able to make correct decisions based on the analysis of the Elliott theory.
It is clear that an article can only be introductory, you can read more and learn from the book, Mastering the Elliot Wave, although I do want to leave enough hints for you to decide if this theory makes sense for you.

impulsive waves

The impulsive section consists of 5 well-differentiated waves:

  • Then 1
    It is only possible to recognize once the movement has developed. It usually suffers a strong correction, usually greater than 50%.
    To recognize it, it is necessary to use chart analysis. The first warning will be the break of a trend, bearish or bullish, and the usual second will be a trend change figure, such as an HCH.

  • Then 2
    It is the correction of Wave 1. The minimum correction should be at 61.8% Fibonacci levels, and usually at 76.4%.

  • Then 3
    It is confirmed when it exceeds the maximum level of Wave 1, and its projection is at the 161.8% Fibonacci extension of the movement developed by Wave 2.
    This Elliot Wave is the strongest of the three impulsive waves, 1, 3 and 5. It will never be smaller, if so, the Wave count should be started again, since we would be facing another different major movement.

  • Then 4
    It is a retracement of Wave 3, which in no case should be less than the maximum price of Wave 1. Normally it is the least of the 5 waves that make up the impulsive movement, it is more irregular in its behavior and should be around the 38% Fibonacci level of Wave 3.

  • Then 5
    It is the last impulsive section, which must exceed the maximum of wave 3, with a projection of 161.8% measuring the movement of wave 4, and in length it is quite similar to Wave 1.
    The volume usually increases, although the movement is not as significant, being a distribution phase in an upward movement or an accumulation phase in a bearish movement.

Corrective waves

If we talk about a retelling of an uptrend, they would be bearish Elliot Waves. There are three waves called a-b-c, in the opposite direction to the previous trend.

  • Onda a
    It is a retracement of Wave 5, which usually takes the price to the high of Wave 3.

  • Onda b
    It is a correction of Wave A, which is usually between 50% and 62% of the movement, and in no case exceeds 75%.

  • Then c
    It has a movement similar in size to Wave a. It is between 150% and 161.8% of Wave b, in an extreme case, 261.8% of Wave b.