Elliott Waves Analysis – Overlapping Between Corrective Waves
Elliott defines a five waves structure as an impulsive wave and a three waves one as a corrective wave. This is what the Elliott Wave principle is and its simplicity is actually the one that makes it so complicated. This is due to the fact that different waves of different degrees are coming and form at the same time so the trader needs to know how to differentiate between those different degrees. An impulsive wave, for example, can be only the 1st wave of an impulsive wave of a bigger degree, or the 3rd wave, or the 5th one, or it can be the a-wave of a zigzag, the c-wave of a zigzag or the c-wave of a flat pattern. All these possibilities make the whole Elliott Wave count process a difficult one and the only way to have a clue as for where a specific count starts/ends are to interpret it from a top/down analysis point of view. This means one should start with historical data based on the monthly charts or higher, then go on the lower time frames, step by step, finding impulsive and corrective waves, in order to come to a time frame small enough that a trade can be made. One way to make a difference between the places where an impulsive wave may appear is to look at the two corrective waves (the 2nd and the 4th wave) and check if they are overlapping. The overlapping principle, while a very simple one, is differentiating between different places an impulsive wave may or may not appear.
Overlapping refers only to the two corrective waves in an impulsive move, namely to the 2nd and the 4th wave. The whole idea is that no parts of the two waves should come into the same area. If this is happening, then the whole impulsive wave actually is not impulsive, but corrective. Therefore, overlapping is helping traders knowing if an impulsive wave is really an impulsive wave or it is a corrective one. However, as with the overall Elliott Waves theory, things are not that easy and simple, but a bit controversial. In reality, the overlapping principle opens the gates for two distinct possibilities when it comes to an impulsive wave, both of them extremely important. One is referring to the classical impulsive move we mentioned so far in our Forex Trading Academy project, and another one is based on overlapping.
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Overlapping in a Classical Impulsive Wave
As a rule of thumb, in a classical impulsive wave overlapping is not allowed. This means that no parts of the 4th wave should not go into the territory of the 2nd wave. Careful about interpreting the above statement as it can be a tricky one. The territory of the 2nd wave is not defined by the one that starts from the beginning to the end of it! The real territory is defined as the area between the highest point in the 2nd wave and the lowest point reached by the market. This is a classical mistake traders make and it may result in fatal losses. If this principle is respected, and all the other rules of an impulsive wave that we discussed in previous articles are respected as well, it is being said that a five waves structure is completed. However, is it possible for the 2nd and 4th waves to overlap and still to have an impulsive wave? The answer is yes!
Impulsive Waves that Overlap
This is one of the trickiest things in Elliott Waves theory and it needs a clear description in order for it to be properly understood. Keep in mind that the Elliott Wave principle is basically a logical process that leaves no room for error. In other words, at one moment of time, a trader may corner a market, in the sense that based on a top/down analysis logical process, the market is not possible to form but an impulsive wave. For example, if the waves a and b of a flat or zigzag are completed, or all the previous four waves in a classical impulsive move are completed as well, then the logical thing is to expect an impulsive wave for either the c-wave of a flat or zigzag or the 5th wave of an impulsive wave. This five waves structure of its own can have the 4th and the 2nd waves to overlap. If this is happening, Elliott found out that ALL the waves in this structure are actually corrective ones, even though, in the end, they are being labeled with numbers. There are multiple names for this pattern, like a terminal triangle, or terminal activity, etc., and this comes from the fact that, indeed, the move appears at the end of an impulsive or corrective wave. Such a logical process can be used backward as well. Consider you are expecting an impulsive wave to form in one of the situations described above. However, no matter how hard you try to find a five waves structure, the outcome shows only corrective waves. If this is the case, overlapping MUST be present, as this kind of terminal pattern must have the 2nd and the 4th waves overlapping. If that is indeed the case, we can say the pattern is correctly identified. Rookie traders that are not familiar with in-depth Elliott Waves analysis principle have a well-known pattern that indicates terminal activity. This is the classical rising or falling wedge. A terminal pattern that is overlapping, in the end, is looking like a wedge! Therefore, a reversal pattern, which is normal if one considers that this terminal activity is forming at the end of a pattern. We all know that a rising wedge is falling and a falling wedge is rising, and this should be the case in this instance as well. The nature of a wedge is being given by its trend lines. In a terminal pattern like the one Elliott discovered, connecting the end of the 1-3 and the 2-4 waves will result in a wedge looking like a pattern. The moment the 2-4 trend line is broken is considered to be the end of the pattern, therefore the end of the overall impulsive wave.
As you can see from this whole article, a single and simple principle like the overlapping one, can influence a count and change it from its core. Knowing all these tips and tricks that are part of the overall Elliott Waves theory can only make a trader excel and find the best setups to trade.
Other educational materials
- How to Trade 2nd and 4th Waves
- The All-Important B Wave Retracement
- What Are Corrective Waves?
- Trade Forex with Simple Corrections
- Complex Corrections in Elliott Waves Theory
- Types of Flat Patterns
Recommended further readings
- “A STUDY TO UNDERSTAND ELLIOTT WAVE PRINCIPLE.” Prasath, S. Naveen.
- “The security price movements with Fibonacci series numbers.” Niromand, Atefeh, and Azam Niroomand. In e-Commerce in Developing Countries: with focus on e-Tourism (ECDC), 2016 10th International Conference on, pp. 1-7. IEEE, 2016.