Look at stock market pricing data on any given day, week, month or what have you, and the immediate challenge of EWT practitioners becomes clear. There’s no immediate way of telling “where” you are at any given point in a cycle.
To make some conclusion about that requires that you study the movement of price and be able to accurately count and label the waves you find.
Fortunately, Elliott Wave Theory is a rules-based system and those rules provide guidance that gives you a solid foundation from which to proceed.
In considering impulse waves, there are three rules to keep in mind (in addition to the structural definition of an impulse, which identifies them as being made up of a total of five waves). These are:
Rule #1 – Wave 2 cannot move below the beginning of Wave 1
Rule #2 – Wave 3 will never be the shortest of the three impulsive waves?
Rule #3 – Wave 4 will not extend beyond the boundary established by Wave 1
These rules are absolutes. They can never fail, they can only be failed, and if you start counting waves and find that any of the above have been violated, then the count is incorrect, and an alternative count must be found.
Let’s take a closer look at the rules and what they mean.
Rule #1 – Wave 2 cannot move below the beginning of Wave 1
Recall the phrase “following the impulse.” Implicit in that phrase is the notion of progress, and in the stock market, progress is defined as price appreciation. To see price appreciation, two conditions must be met:
1) Wave 2 never retraces more than 100% of Wave 1 (if it did, then there would be no upward progress).
2) Wave 3 always carries beyond the boundary set by Wave 1 (again, if it did not, then there would be no upward progress).
On some occasions, Wave 5 may not progress beyond the boundary established by Wave 3, but overall, impulsive progress has still been made. If and where this happens, it is referred to as a “Failed Fifth.”
Below, you’ll see this represented graphically:
BULL MARKET
BEAR MARKET
Rule #2 – Wave 3 will never be the shortest of the three impulsive waves
Note that this does not imply that Wave 3 must be the longest of the waves. In practice, however, Wave 3 winds up being the longest wave in the set about 75% of the time in stocks, commodities tend to extend in fifth waves. Here’s the graphical representation of this rule, noting the Error chart has wave (iii) the shortest which is an incorrect Elliott wave count
BULL MARKET
More typical of wave three below, a very clear larger structure within wave (iii). Also, if a wave three is extended, then expect wave one and five to be roughly the same size.
BEAR MARKET
Rule #3 – Wave 4 will not extend beyond the boundary established by Wave 1
Wave 4 is a corrective wave, so the price will retreat from the new high established by Wave 3, however, when Wave 4 pulls the price back down, it will not do so to the point that it falls below the peak established in Wave 1, as demonstrated in the figure below:
BULL MARKET
BEAR MARKET
Having seen what these wave forms look like in a bull market, now let’s look at them in waves A and C in a bear market.
Extensions Explained
In some instances, impulsive patterns appear to have more than five waves. Often (but not always) this is because one of the three rules mentioned above have been broken and the count is simply off. In some cases though, what you’re seeing is the fact that the five-wave set has developed a highly complex and intricate pattern. Elliott referred to this phenomenon as an extension.
Remember, however, that wave patterns are fractal in nature, so if a highly complex form is detected, then the extension will invariably take the structure of another five-wave pattern embedded in the impulse you’re looking at.
In looking at the historic data, if and where extensions occur, they do so in only one of the three impulse waves in an impulsive pattern. The chart below outlines the possible scenarios you’ll encounter: the first extension is in Wave (i) and then an extension in Wave (iii) which is the most common in stocks and then an extension in Wave (v) and this tend to happen in commodities.
There’s a certain predictive power in knowing that historically, only one of the impulsive waves will develop an extension (if any do at all). If you have identified an extension in Wave 1 or 3, you can say with confidence that you won’t see one developing in Wave 5.
Also note that (again, based on the entire body of historic pricing data), if Waves 1 and 3 are of similar length (although Wave 3 must, of course, be longer than Wave 1 in order to abide by the three rules set forth), then odds are excellent that Wave 5 will be long and extended.
These things are at least part of the explanation for why seasoned EWT practitioners seem to have clairvoyant powers when it comes to predicting the future movement of the market.
Note that in some cases, it may not be possible to tell precisely which wave has extended. It’s not really a necessary piece of information to know. The important thing is that the three rules are adhered to.
If you see an extension, it’s entirely possible that the extension will itself develop an extension, leading to the creation of an even more complex and intricate pattern. Most commonly, based on the historic pricing data, you’ll see:
• A Wave 3 extension of the extended 3rd Wave
• A Wave 5 extension of the extended 5th Wave
See the chart below for a graphical example:
As before, we’ve been looking at extensions in an impulse pattern in a bull market but remember that impulsive patterns also occur in Waves A and C in a bear market. We’ll illustrate those examples just below. Remember, Wave A of a bear market is not always a five-wave move (in the case of a “Flat Correction”).
Exceptions To The Three Rules For Impulsive Patterns
Rules were made to be broken, and Elliot identified two “exceptions” to the (mostly) ironclad rules set forth earlier. These are:
• A “Failed Fifth,” where Wave five does not extend beyond the boundary established by Wave 3 (this is called “Truncation”).
• And The Diagonal Triangle, which corresponds to the wedge in bar charting analysis. The only place you’ll see this is in Wave 5 and in Wave C. Here, the key feature is that Wave 4 DOES move into the pricing territory of Wave 1, and that each wave is built on a three-wave structure.
Summary
• There are three rules governing the structure of an impulse. These are:
• Rule #1 – Wave 2 cannot move past the beginning of Wave 1
• Rule #2 – Wave 3 will never be the shortest of the three impulsive waves
• Rule #3 – Wave 4 will not extend beyond the boundary established by Wave 1
• There are two instances where the three rules above can be broken (exceptions). These are:
• A “Failed Fifth”
• And a Diagonal Triangle
• One of the impulsive waves may develop a complex pattern known as an extension.
• If Wave 3 is extended, statistically, Wave 5 will not be
• If Waves 1 and 3 are similar in length, statistically, we can expect that Wave 5 will be both long and extended
• The pattern can be labelled 1-9 if and where it cannot be determined which wave is extended
• It is possible that one of the extensions may itself be extended, developing an even more complex pattern. Most commonly this is found in:
• A third wave extension of an extended third wave
• Or a fifth wave extension of an extended fifth wave