Elliott Wave Theory: The Complete Guide to Market Cycles (2025 Edition)
"The market is a fractal."
This statement sounds like something from a physics textbook, but it is the foundation of one of the most widely used—and widely misunderstood—methods of technical analysis: The Elliott Wave Theory (EWT).
Developed by Ralph Nelson Elliott in the 1930s, the theory proposes that market prices unfold in specific patterns (waves) driven by collective investor psychology. These patterns repeat on every timeframe, from the 1-minute chart to the 100-year cycle.
At CuriousFolk, we view Elliott Wave not as a crystal ball, but as a GPS. It doesn't tell you exactly when you will arrive, but it tells you where you are on the map. Are we in the early stages of a bull market? Or are we at the precipice of a crash? EWT provides the context.
In this deep dive, we will strip away the complexity. We will focus on the core "5-3" structure, the Fibonacci relationships that bind the waves together, and the practical "CuriousFolk Rules" for trading these cycles.
1. The Core Concept: The 5-3 Wave Cycle
According to Elliott, markets move in two phases:
- Motive Phase (Impulse): Moves with the main trend. Consists of 5 waves.
- Corrective Phase: Moves against the main trend. Consists of 3 waves.
The Motive Waves (1, 2, 3, 4, 5)
Let's assume a Bull Market.
- Wave 1 (The Spark): Price rises from a bottom. This is often driven by "Smart Money" accumulation. Sentiment is still bearish.
- Wave 2 (The Test): Price retraces a significant portion of Wave 1 (often 61.8%). Bears try to push it down again, but fail to make a new low.
- Wave 3 (The Boom): This is usually the strongest and longest wave. The "Crowd" realizes the trend has changed. Volume explodes. Fundamental news turns positive.
- Wave 4 (The Pause): Profit taking. Price consolidates sideways or dips slightly.
- Wave 5 (The Climax): The final leg up. Driven by retail euphoria and FOMO. Divergence often appears on indicators (RSI).
The Corrective Waves (A, B, C)
After the 5-wave motive phase is complete, the market must correct.
- Wave A (The Drop): The first leg down. Investors think it's just a dip.
- Wave B (The Trap): A relief rally (Dead Cat Bounce). It fails to reach the Wave 5 high.
- Wave C (The Flush): The devastating final drop. Panic sets in. Price breaks below the Wave A low.
Table 1: Wave Characteristics Summary
| Wave | Type | Sentiment | Volume | Strategy |
|---|---|---|---|---|
| Wave 1 | Motive | Disbelief / Bearish | Low to Moderate | Watch / Wait |
| Wave 2 | Corrective | Fear / "Double Bottom" | Low | Buy the 61.8% Retracement |
| Wave 3 | Motive | Recognition / Bullish | High (Explosive) | Hold / Add |
| Wave 4 | Corrective | Profit Taking | Moderate | Buy the Breakout |
| Wave 5 | Motive | Euphoria / Greed | Low (Divergence) | Sell into strength |
| Wave A | Corrective | Denial | Increasing | Short |
| Wave B | Motive (Trap) | Hope | Low | Short the rally |
| Wave C | Corrective | Panic | High | Cover shorts |
2. The Three Cardinal Rules
Elliott Wave is subjective, but there are three rules that cannot be broken. If they are broken, your count is wrong.
- Rule 1: Wave 2 cannot retrace more than 100% of Wave 1. (If price makes a new low, the pattern is invalid).
- Rule 2: Wave 3 can never be the shortest of the three impulse waves (1, 3, and 5). It is usually the longest.
- Rule 3: Wave 4 can never enter the price territory of Wave 1. (They cannot overlap).
3. Fibonacci: The Glue of the Universe
Elliott Wave Theory works hand-in-hand with Fibonacci ratios. The waves tend to respect these mathematical proportions with eerie precision.
Measuring the Waves
- Wave 2 Target: Usually retraces 50% or 61.8% of Wave 1.
- Wave 3 Target: Usually extends 1.618x the length of Wave 1.
- Wave 4 Target: Usually retraces 38.2% of Wave 3.
- Wave 5 Target: Often equals the length of Wave 1, or reaches the 0.618 extension of Waves 1+3.
CuriousFolk Strategy: We use the "Fibonacci Extension" tool to project the top of Wave 3. When price hits the 1.618 level, we start looking for exit signals.
4. CuriousFolk Guide to Trading the Waves
You don't trade every wave. You trade the high-probability setups.
Setup 1: Buying the Wave 2 Bottom
- Logic: Wave 1 has confirmed a change in momentum. Wave 2 is the discount.
- Entry: Wait for price to retrace to the 61.8% Fib level of Wave 1. Look for a reversal candle.
- Stop Loss: Just below the start of Wave 1. (Tight risk).
- Target: The top of Wave 3 (massive reward).
Setup 2: Trading the Wave 4 Breakout
- Logic: Wave 4 is often a complex sideways pattern (triangle or flag).
- Entry: Buy the breakout of the consolidation pattern.
- Target: The Wave 5 high.
What NOT to Trade
- Wave B: It is a trap. Choppy and unpredictable.
- Wave 4 (Inside): Don't try to trade the chop inside the correction. Wait for the resolution.
5. Fractals: Waves Within Waves
Here is where it gets trippy. Every wave is made up of smaller waves.
- A Wave 1 (Motive) on a Weekly chart is composed of a 5-wave structure on the Daily chart.
- A Wave 2 (Corrective) on a Weekly chart is composed of an A-B-C structure on the Daily chart.
This "Russian Doll" structure allows day traders to use Elliott Wave principles on 5-minute charts, while macro investors use them on Monthly charts.
6. Historical Case Studies
The Great Depression (1929)
R.N. Elliott actually predicted the market bottom in 1935 using his theory. He identified that the 1929-1932 crash was a massive A-B-C correction of the previous Supercycle.
The Crypto Bull Run (2017)
Bitcoin exhibited a textbook 5-wave structure.
- Wave 1: $0 to $1,000.
- Wave 2: Drop to $200.
- Wave 3: Rally to $10,000 (The viral phase).
- Wave 4: Correction to $6,000.
- Wave 5: Blow-off top to $20,000.
- The ABC Correction: The 2018 "Crypto Winter" followed immediately.
7. The Psychology of the Crowd
Why does this happen?
- Wave 1: Disbelief. "It's just a rally in a bear market."
- Wave 2: Fear. "See? I told you it would fail."
- Wave 3: Recognition. "Wait, the fundamentals are actually good."
- Wave 4: Profit Taking. "Let's lock in some gains."
- Wave 5: Greed. "This will go up forever! Mortgage the house!"
Elliott Wave is essentially a map of human emotion.
8. Common Criticisms and Pitfalls
"It's Too Subjective"
Critics say if you put 10 Elliott Wave analysts in a room, you'll get 12 different counts.
- CuriousFolk Response: True. The "Count" is always a hypothesis. That's why we rely on the Invalidation Levels (The Cardinal Rules). If the rule is broken, the hypothesis is wrong, and we exit. We don't trade the prediction; we trade the risk/reward.
"Analysis Paralysis"
Traders get so obsessed with labeling every sub-wave (Is this iv of 3 or i of 5?) that they miss the obvious trend.
- CuriousFolk Response: Keep it simple. Focus on the major pivots. If you can't count it clearly, skip it.
9. Frequently Asked Questions (FAQ)
Q: Does Elliott Wave work on all assets? A: It works best on assets with high liquidity and mass participation (S&P 500, Gold, Bitcoin, Forex). It works poorly on penny stocks or low-volume assets where price can be manipulated by a single player.
Q: Can I use EWT alone? A: No. Always combine it with RSI (to spot Wave 5 divergence) and Volume.
Q: What is the "Grand Supercycle"? A: The largest wave degree, spanning centuries. Some theorists believe we are currently in the final stages of a Grand Supercycle that began in the 1700s.
10. Conclusion: Surfing the Market
Trading without Elliott Wave is like sailing without a weather report. You might survive, but you will likely be caught off guard by the storm.
By understanding the 5-3 cycle, you learn to curb your greed at the top of Wave 5 and control your fear at the bottom of Wave 2. You stop chasing the "Noise" and start riding the "Tide."
At CuriousFolk, we use EWT to answer the most important question in investing: "What time is it?"
Disclaimer: This article is for educational purposes only. Elliott Wave analysis is theoretical.