What Happens After Elliott Wave 5?
Under Elliott wave theory, market prices alternate between an impulsive and corrective phase in each of five lower-degree wave sequences. Corrective sequence a-b-c often takes various forms including flats, zigzags and triangles.
When fifth waves extend, their correction typically retraces less than 38-78% of its original length – this process is known as “truncation”.
Wave 5
Once an impulse sequence ends, market participants take profits, leading to prices to decline temporarily in an effort to correct themselves. When its second wave begins, traders place protective stops near its lower edge so when prices move higher they encounter buying pressure that pushes prices even higher.
The second wave usually unfolds as a zigzag and typically retraces over 38% of wave A’s length, signaling to market participants that the trend has turned.
Sometimes zigzags will be interrupted by flat or diagonal waves, forming corrective sequences which tend to overlap waves 1 and 3, as well as be deeper than their respective retracements. You can use the rule of alternation when forecasting the length of wave 5. Do this by connecting both ends of waves 1 and 3, placing a parallel line through their apexes to predict where wave 5 will end up. This will predict its termination point.
Wave 6
After Wave 5, corrective waves may arise – a typical pattern in Elliott wave theory but which may vary based on market dynamics; hence it is vital that traders utilize an array of technical analysis tools and market considerations when trading.
Elliott Wave Theory’s core principle states that waves 2 and 3 should never overlap, with Wave 4 not retracing more than 100% of Wave 3. These rules can easily be understood with Fibonacci ratios; one popular multiple of wave 5 being 1.618 times net length of waves 1 through 3.
Wave fours tend to be sideways affairs that move price within a range, providing the foundation for the final fifth wave. They tend to be less dynamic than Wave 3s and tend to have lower volumes; additionally they may retrace less than 38.2% of Wave 3. Alternatively they could end at subwave 4 of the previous three wave correction.
Wave 7
At the peak of a 3rd wave there will be widespread recognition that a new trend has begun; volumes, volatility, and sentiment will likely all increase significantly; typically this wave acts like an impulse wave.
Wave four is a clear corrective wave and prices may meander sideways for an extended period. Volume is significantly less than wave three.
Wave 4 can take various forms – zigzags, flats or combinations but never triangles. Wave 5 typically matches up with waves 1 and 3, however sometimes truncations (failure to push beyond wave 3’s pivot) occur after particularly strong 3rd waves which is an early warning that either mislabeling wave 3 occurred, or there may be an ongoing complex W4 trend that is going forward that could potentially result in devastating sell offs.
Wave 8
Typically, when markets move into corrective patterns, they retrace an impulse wave before reaching Wave 5. This is one of Elliott’s rules and it works effectively provided the corrective wave doesn’t violate other technical analysis tools or market considerations.
General principles indicate that Wave 5 length should equal 1.618 times its net length based on Waves 1, 2 and 3. To calculate this multiple, connect Waves 2 and 3 via trend lines or employ Fibonacci ratios to calculate it.
In most instances, corrective waves will not fully retrace Wave 5; however, double or triple three corrections can happen, known as “truncations”, indicating the market’s readiness to shift into a different direction and often led by strong impulse waves.
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