Elliott Waves Theory – Patterns with Failures – What Are They and Their Implications
Elliott discovered multiple types of patterns a market can form and one of the most powerful ones are those that have a so-called failure, or patterns that fail. What is this failure and why it is so important to know that these patterns even exist? A pattern with a failure shows the inability for the price to move beyond a specific level. There are many situations where price fails to do that, and most of them are met in corrective waves. The reason why patterns with failures are so important is because they are actually a sign that the market is going to make an explosive move in the opposite direction. Most of the times an important top or bottom is to be found after such failures occur. Therefore, knowing when a pattern with a failure forms and what the implications for future price action are, is vital for the overall trading process using the Elliott Waves theory. Below, there are the most important things to know about patterns that contain a failure.
Two Types of Failures
Elliott discovered that failures can appear in two situations, and these situations are actually given by the nature of the overall move: impulsive or corrective. Therefore, patterns with failure appear in both impulsive and corrective waves, with the most common types happening in corrective waves.
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Failures in Corrective Waves
We know by now that corrective waves are either simple or complex corrections, and failures are referring to simple corrections that are either stand-alone patterns or part of a complex correction. That being said, the only simple correction that can be subject to a failure is a flat pattern. In the articles dedicated to the flat patterns here on our Forex Trading Academy, there are three categories of flats that one can identify, based on the retracement level the b-wave makes into the territory of the previous a-wave. If the b-wave retraces between 61.8% and 80% of the previous a-wave, this category will contain two types of flats subject to failures: a flat with a b-failure and a flat with a double failure. In the first instance, the c-wave (the only impulsive move in a flat) will completely retrace the b-wave but will not go much beyond the end of the a-wave. The move to follow after its completion should be an explosive one in the opposite direction of the flat.
The second type of flat, the one with a double failure, implies the c-wave fails to completely retrace the previous b-wave. This is an even more powerful pattern than the previous one and usually, it is happening so fast that traders are being taken completely by surprise. If the b-wave in a flat is retracing between 80% and 100% of the previous a-wave, there is only one flat that is subject to a failure. This is happening, again, when the c-wave fails to completely retrace the previous b-wave. The last category calls for the b-wave to retrace between 100% and 138.2% and in this case we also have a single possibility for a failure to form. Again, it is referring to the c-wave, that fails to completely retrace the previous b-wave. All the flats with failures are more powerful than the other types of the flats that the market may form (with the exception of a running flat, of course!), and in particular the flat with a double failure. Therefore, from now on, when seeing such a pattern, just remember that the real move you want to catch is coming in the opposite direction than the one the flat is actually traveling.
Failures in Impulsive Waves
The only possibility to have a pattern that fails in an impulsive wave is when the 5th wave fails to move beyond the end of the previous 3rd wave. This situation is so powerful that it actually implies a major top or bottom is in place and an aggressive move in the opposite direction is about to follow. Such a pattern is being called an impulsive wave with a fifth wave failure and shows the inability for the price to move beyond the end of the previous 3rd wave. It is a pattern that shows strength in the other direction and it is quite easy to spot. The reason for that comes from the fact that a 5th wave failure can only form when the overall impulsive wave has a third wave extension. Therefore, it is not possible to see such a pattern if the whole move is a first wave extension or a 5th wave extension. Moreover, in such instances, the 5th and the 1st waves are so similar that they are easy to spot and, as a consequence, to trade this move. As a matter of fact, it doesn’t really matter if the whole pattern is traded on the spot, right when it forms, or after it. What matters the most is to fully understand that it shows a significant market top or bottom and the trend that starts after it is a powerful one. A very important factor is the time frame this pattern appears on as well. If it is forming on the monthly chart, for example, you can imagine the significance of the trend to follow as it will have huge implications for years and years to come. On the other hand, a fifth wave failure on the hourly chart should be viewed as a pattern that shows a reversal taken place and a trend of a lower degree should start from that moment on. As you can see, patterns with failures are quite common with Elliott waves as flats are quite common. There are no less than nine type of flats, not including the running flat here, and out of those types, four of them are subject to at least one failure. All in all, every time there is a pattern with a failure that forms, it should be considered as a strong signal that a powerful move in the opposite direction is about to follow. Make sure that you position for that move, even at the expense of not trading the c-wave in a flat.
Other educational materials
- Trading with the Apex of a Contracting Triangle
- Types of Contracting Triangles
- Special Types of Triangles
- Types of Expanding Triangles
- Trading with X Waves
- The Concept of a Running Correction
Recommended further readings
- Fundamentals of investments: valuation and management. Dolvin, Steven D., Bradford D. Jordan, and Thomas W. Miller Jr. 2012.
- An integrated stock market forecasting model using neural networks. Weckman, G. R., Lakshminarayanan, S., Marvel, J. H., & Snow, A. (2008). International Journal of Business Forecasting and Marketing Intelligence, 1(1), 30-49.