What Happens After Elliott Wave 5?

Elliot observed that price movements in financial markets were repetitive and predictable, always appearing in five waves. He studied these waves’ formation for insight.

Each impulse wave is followed by a corrective wave. Simple corrections tend to zigzag in nature and rarely exceed retracing more than 38% of wave 1 length. Complex corrections involve different three-wave patterns forming multiple corrections simultaneously.

Wave 5

The final impulse wave in a dominant trend tends to be the most overpriced due to buyers being most bullish at this point and buying on any dips, creating buying momentum that pushes prices even higher and creating an unsustainable price rise that eventually plateaus out.

Market participants will start taking profits at this point, leading prices to decline and form wave 2. Elliott Wave Theory refers to this corrective action as a sharp reversal.

Corrective waves typically extend longer than either wave 2 or wave 4, and their corrective sequence a-b-c can include zigzags, flats, triangles or complex variations such as wedge-shaped diagonals. Impulse wave guidelines still apply:

Wave 6

After an extension of a 5th wave impulse, its subsequent correction will typically retrace between 38-78% of its length due to market behavior’s tendency for complex patterns to emerge and subside over time.

Elliott Wave Theory provides one exception when a leading diagonal pattern that always subdivides into zigzags appears; this special case does not violate its principles.

Importantly, in an impulsive pattern a fifth wave cannot retrace more than 100% of its length from its preceding third wave and cannot be shorter than any of Waves 1, 3, and 5. Truncations do occur, usually after particularly powerful third waves have taken place; when this occurs truncated fifth waves must still contain five subwaves as this indicates high strength underlying this sequence and the probability of reversals being imminent.

Wave 7

Elliott wave sequences often end with the final impulse wave having the largest correction, as this wave represents the highest overpricing in its entirety. Therefore, contrarians will often short an asset at this point as an effective form of hedge.

Remind yourself that an Elliott Wave Theory standard states that the third wave must never be the shortest of all waves; so when examining an Elliott wave chart it is essential to look out for this indicator.

Impulsive waves usually extend in waves 3, but can occur in any wave, particularly commodities markets. Extensions within an impulsive wave usually happen on condition that wave 3 does not become the shortest, as any shortening signals an impending major trend reversal.

Wave 8

Wave 8 of an ascending trend is typically the longest and strongest impulse wave, pushing past the peak of Wave 3. If it fails to do this, there may be further complex corrections taking place in its wake.

In most instances, the first pullback from an established trend will often appear as a zigzag correction. This occurs because participants who bought assets during wave 1 often take profits early and prices then decrease, leading to a zigzag correction.

Elliott Wave Theory dictates that Wave 4 cannot overlap with Wave 1 territory and must retrace 38% of wave 3. Other corrective patterns, such as flats and triangles may also form, but are typically less frequent and require extensive analysis for accurate counting.

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