What Invalidates an Elliott Wave?
Elliott Wave Theory provides guidelines for spotting patterns in price action. While these rules can be beneficial, following them closely on live charts can sometimes prove more challenging.
Elliott observed that the ups and downs in prices caused by collective psychology typically followed specific repeating patterns, known as waves. Each wave contained both progressive and corrective components.
Wave 2
One of the more common Elliott Wave errors is mistakingly believing that a retracement in wave 2 must represent a complex correction, when in reality it often represents the development of lesser degree 1-2 waves within an overall corrective wave pattern.
Understanding that the Elliott Wave Principle are guidelines and not strict requirements is paramount to effectively using an Elliott wave pattern analysis. While occasionally these guidelines may be broken, most often they remain intact. As such, being able to assess probabilities is crucial when approaching such patterns.
Wave 3
Elliott made one of his key observations is that markets move in fractal patterns. At each wave degree, motive waves move with the trend while corrective waves go against it; and that these same patterns repeated themselves time after time.
Elliott created guidelines that help us recognize these recurring patterns, though these guidelines are not absolute rules; rather they serve as helpful guides that reduce risk in trading. One such guideline states that Wave Two cannot retrace more than 100% of Wave 1.
Alternation is another key guideline, where waves 2 and 4 should alternate in form between sharp and mild forms. This practice helps traders reduce risk when their expected pattern becomes invalidated due to unexpected economic news or changes in market sentiment, among other sources. Recognizing when your Elliott wave count has become invalidated is vitally important so you can reevaluate and adapt accordingly.
Wave 4
Elliott Wave Theory dictates that Wave 4 should not overlap with the price territory of Wave 1. Nonetheless, this guideline may be too stringent as it can be hard to identify exactly when this overlap occurs.
Wave 2 and 4 in impulses often consist of an unpredictable mix of sharp forms (zigzags and combos) with sideways forms (flats and triangles), making them very difficult to correctly label. Furthermore, their ends may be mislabeled leading to inaccurate Wave counts.
Keep in mind that double and triple zigzags have seven and 11 waves respectively; do not confuse these with normal three-wave corrections. In addition, due to Elliott Wave Theory’s fractal nature, smaller waves must align with larger patterns for accurate counting; otherwise an Elliott Wave analysis would become invalidated and lead to poor analysis results. Failure to adhere to this rule often results in poor analysis outcomes for traders.
Wave 5
Some guidelines governing specific wave patterns are more strict than others, including alternation. According to this rule, waves two and four in any five-wave sequence will alternate their forms; for instance, an abrupt move in wave two might be followed by an indirect mild movement in wave 4.
Rich Swannell of Elite Trader Secrets asserts that this guideline is only approximately 80% accurate; nonetheless, it serves as an extremely helpful tool in Elliott wave analysis.
An important rule to abide by for Elliott wave counts is that no fifth wave should retrace more than 100% of its previous fourth wave in degree terms. If this rule is broken, an incorrect fifth wave count cannot survive and an Elliott wave count would become invalidated immediately.
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