What Happens After Elliott Wave 5?
Truncations is defined as when the fifth wave in an impulsive sequence fails to surpass the price extreme of its third wave and indicates either strength or weakness within an asset and potential market reversals.
When a 5th wave extends, its corrective should retrace to within the range of the previous 4th wave by one less degree – this is known as alternation and typically manifests itself through zigzagging, flattening or combinations thereof.
Wave 1
When Wave 5 of an impulse sequence extends, its correction (Wave 4) rarely retraces more than approximately the endpoint of Wave 4, usually no more than 1.618% the distance covered by Wave 1.
As with the Rule of Alternation, this guideline is further supported by the fact that corrective waves in larger trends tend to retrace less than their predecessor and the smallest motive sub-wave of correction tends to be strongest; hence a sharp correction in wave 2 usually means complex correction in wave 4.
Wave 2
Wave 2 is an important wave in any structure; typically retracing less in terms of price and duration than Wave 1. Usually creating bearish sentiment as momentum indicators point toward potential tops in price levels.
Wave 2 may incite a false break of the trendline at its boundary, leading to bearish conviction before Wave 5 takes hold of the market and moves in its direction.
As a rule of thumb, a sharp move in Wave 2 generally portends an equally aggressive yet gradual move in Wave 4. Rich Swannell notes that alternation only occurs 61.8% of the time in actual markets and recommends using trend lines to project where Wave 4 might end.
Wave 3
Wave 3 often marks a turning point for a new trend, when price breakouts, continuation gaps, volume expansion and increased breadth are evident.
Impulsive waves usually do not retrace more than 38.2% or 61.8% of their previous wave 1 in their initial corrections; this holds true even for triangle corrections.
Truncations occurs when Wave 5 doesn’t extend past the end of its preceding Wave 3. This may serve as an early warning signal that more serious market reversals may be on their way.
Wave 4
The third wave of an impulse typically generates the greatest volume, price movement and breadth; it is also often the one to extend further.
As prices surge upward, sentiment becomes optimistic, often prompting market participants to take profits and cause prices to decrease in what is known as a second wave.
Common wisdom suggests that corrective waves shouldn’t retrace more than 100% of initial gains; however, this rule can be adjusted according to other considerations.
Reversals in sentiment often occur at the fourth wave and signify its beginning; when this occurs it signals the start of a new trend or pattern known as truncation, as well as signalling an impending impulse wave with five waves in it.
Wave 5
The fifth wave in an impulse is typically a sideways counter-trend correction. Prices move impulsively lower while volume and sentiment shift bearish; often covering much further ground than previous waves.
As a rule, truncated fifth waves tend to extend more frequently than normal impulse waves; however, there may be exceptions. Furthermore, such waves cannot retrace more than 100% of their preceding impulse wave.
As a rule of thumb, when wave 2 is sharp expect wave 4 to be sideways; conversely (excluding triangles which don’t fulfill alternation). Furthermore, within corrective ABC waves if A is complex expect B to be simple while if A is flat expect C to have more complex combinations.
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