How to Treat Patterns with Failures in Forex
Elliott discovered multiple types of patterns a market can form, and one of the most powerful types is those that have a so-called failure, or patterns that fail. What is this failure, and why is it so important to know that these patterns even exist? A pattern with a failure shows the inability of 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 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. Outlined below 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 named by the nature of the overall move: impulsive or corrective. So patterns with failure appear in both impulsive and corrective waves, with the most common types happening in corrective waves.
Failures in Corrective Waves
We know by now that corrective waves are either simple or complex corrections, and that failures are 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 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 failure: 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 that follows 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 that the c-wave fails to completely retrace the previous b-wave. This is an even more powerful pattern than the previous one, and it usually happens so fast that traders are taken completely by surprise. If the b-wave in a flat retraces between 80% and 100% of the previous a-wave, there is only one flat that is subject to a failure. This happen 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 refers to the c-wave, which fails to completely retrace the previous b-wave. All the flats with failures are more powerful than the other types of 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, on seeing such a pattern, just remember that the real move you want to catch is coming in the opposite direction from the one the flat is actually travelling in.
Failures in Impulsive Waves
The only possibility of having a pattern that fails in an impulsive wave is when the fifth wave fails to move beyond the end of the previous third wave. This situation is so powerful that it actually implies that a major top or bottom is in place and an aggressive move in the opposite direction is about to follow. Such a pattern is called an impulsive wave with a fifth-wave failure, and shows the inability of the price to move beyond the end of the previous third wave. It is a pattern that shows strength in the other direction, and is quite easy to spot. The reason for that is because a fifth-wave failure can only form when the overall impulsive wave has a third-wave extension. It is therefore not possible to see such a pattern if the whole move is a first-wave extension or a fifth-wave extension. Moreover, in such instances, the fifth and first waves are so similar that it is easy to spot them and, as a consequence, to trade this move. As a matter of fact, it doesn’t really matter whether the whole pattern is traded on the spot right when it forms, or after it. What matters most is to fully understand that it shows a significant market top or bottom, and that the trend that starts after it is a powerful one.
Another very important factor is the timeframe this pattern appears on. If it is forms on the monthly chart, for example, you can imagine the significance of the trend to follow, as it will have huge implications for 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 taking 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 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. You should make sure 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. 2009.
- 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.