What Invalidates an Elliott Wave?
As with seashells and snowflakes, Elliott waves are fractals – that means they can be broken apart into smaller waves for a clearer market overview.
Ralph Nelson Elliott was an eccentric accountant in the 1920s who observed that financial markets followed certain patterns based on collective psychology such as greed and fear.
1. Miscounting corrective waves
Elliott Wave Theory states that five waves move in the direction of trend and are known as motive waves, while three move against it and are called corrective waves. Each wave can further be subdivided into lower-degree waves which alternate between being motive or corrective waves.
Miscounting corrective waves when counting an Elliott wave is one of the most frequent errors. Corrections come in all sorts of shapes and are harder to count than impulses due to choppy overlap patterns that make them harder to find on shorter timeframes.
An important rule to keep in mind when trading impulse waves is that an impulse cannot serve as part of a corrective wave – this means that waves iii of an impulse cycle must not exceed wave one and waves b or c should not extend past wave two.
2. Miscounting impulse waves
Elliott wave theory holds that waves with equal magnitude tend to take on various forms, which necessitates deeper correction at their end impulse. This phenomenon can be explained through alternation: waves tending toward alternate forms.
As illustrated by Tom Joseph Elliott wave studies, an ideal target area for corrective waves tends to be 50% of their preceding impulse wave’s length; however, this rule may be broken in certain instances.
Keep in mind that Elliott wave Fibonacci levels and patterns evolve based on price action, as markets are fractal in nature – much like seashells or snowflakes – meaning smaller patterns may easily fit into larger ones or separate from them as necessary.
3. Miscounting sideways waves
Elliott wave theory allows traders to forecast future price movements by studying patterns and cycles in market charts. Unfortunately, however, wave counting can often result in false predictions and subsequent unsuccessful trades. To avoid these errors, avoid practicing wave counting with care as there can be many pitfalls which lead to incorrect predictions leading to lost trades.
Example: if a correction pattern consists of shallow flat or combination structures rather than deep zigzags, it’s likely not an impulse wave and simply represents sideways movement in the direction of larger trends. Such errors could prove costly as corrective waves should serve to temporarily stop markets before resume their operating trend direction.
Traders should also monitor for low volume during corrective waves, as this could signal that the market has switched to an impulse wave. Traditional technical analysis often doesn’t provide such accurate indicators of this shift; but with Elliott Wave Theory you have this level of validation for trade setups.
4. Miscounting retracements
Elliott Wave Theory can best be understood when approached as a fractal. Like seashells or snowflakes, its pattern fits within larger ones to allow us to predict financial markets more accurately.
Traders employ Elliott Wave Theory to identify price patterns likely to undergo corrections or reversals and exploit those opportunities by entering at the right time with limited risk and defined profit goals. This approach can help them make money.
However, Elliott waves have one key drawback: their accuracy relies upon accurately counting retracements within their wave sequences. If these retracements are miscounted or miscounted altogether, then an Elliott wave loses its predictive power and traders must always abide by the rules for counting retracements within an Elliott wave sequence.
5. Miscounting reversals
Elliott Wave (EW) Theory provides traders with rules and guidelines to identify price swings and patterns on all instruments / charts. This market analysis technique relies on the concept of five impulsive waves moving with the trend followed by three corrective waves going against it.
Misclassifying an impulse wave as a reversal could throw your Elliott Wave analysis off track, so make sure to watch for signs such as:
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