Saturday, May 21, 2011

Wave 1 And Wave 4 Overlap

"Wave 4 does not enter the price territory of wave 1."

This is the most contentious rule in Robert Prechter's Book, Elliott Wave Principle. 

Here is a brief overview of how this rule came into existence.

R.N. Elliott in "The Wave Principle", published in 1938, states,

"Likewise, wave four should not carry to a level as low is attained by wave two. Wave two rarely cancels all of the ground gained by wave one, and wave four rarely cancels all of the ground gained by wave three."

Meaning, wave 4 can go lower than the start of wave 2, which is also the end of wave 1, but not go lower than the end of wave 2, in a bull market. That is my experience as well, that is where I have seen an overlap, wave 4 did not go beyond the start of wave 2.

In the 1946  "Nature's Law", R.N. Elliott states the following in the context of erroneous counting. Where waves abc of wave 2 can be incorrectly counted as 2,3,4 resulting in overlap of 1 & 4.

"Note that wave 4 overlapped wave 1, which it should not do. Overlapping means that the end of wave 4 was lower than the top of wave 1."

The question here is what changed Elliott's view on the wave 1 & 4 overlap between 1938 and 1946? Or this was just an oversight in language, on part of  Elliott, and it should be treated only in the  context of not counting abc as waves 2,3 and 4.

When Elliott made the observation in Wave Principle that wave 4 does not go past beyond the start of wave 2, those observations did not become immaterial by the time he wrote Nature's Law. What happened to the cases where Elliott did see this overlap when he wrote The Wave Principle?

Robert Prechter's "Elliott Wave Principle" , published in November 1978 , is the one widely followed by Wave Practioners today.

Prechter made an attempt to further formalize Elliott's Wave Principle. He reorganized Elliott's observations, separating them under rules and guidelines. And also adding some of his own observations. He introduced a new notation, the WXYXZ, to label combination corrections.

Prechter used the term impulse specifically for the five wave pattern, where wave 1,3 & 5 subdivided into 5-waves each, and wave 1 and 4 did not overlap.

He introduced a new pattern, the diagonal, in which wave 4 almost always moves into the price territory of wave 1. Also within which, the subwave structure is 3-3-3-3-3.

Prechter is right in observing that there are cases where wave 1 overlaps with 4. My experience has been the same, that wave 4 overlaps with wave 1, more often than not. 

Though I am not convinced of the 3-3-3-3-3 structure. In some cases of waves A and C, I have noticed  that one of the 1,3 or 5 developed as a zigzag, instead of a 5-wave pattern, and wave 4 overlapped with wave 1. 

Elliott and Prechter have both documented that wave 4 does overlap with wave 1. And so has been my own experience. 

I think this issue needs to be studied, and we need to further identify under what conditions does this occur. 

I am putting this rule under review, and will continue to observe this phenomenon, and document these observations to come up with a better understanding as to when this happens.

Most Elliot Wave Bloggers wish this issue would just go away. Some others will try to brush these situations under the rug. For many others, it has become a standard practice to point to the wave 1 and wave 4 overlap, to pick on a count which does not match their own bullish or bearish expectations. But I plan to observe and study it as best I can.

Nevertheless, Elliott Wave Principle remains an immensely useful tool in projecting market directions. It may not be perfect but works very well. For example, planes crash, but air travel remains the choice for long distance travelling. Cars break down, but we continue to use them because they are highly reliable and get us around. Human bodies develop ailments, but we continue to live in them as best we can.

Elliott developed his principle based on observations. It is possible some of his observations may have been incorrect. For this particular issue, it may just have been an oversight, purely of language and context. 

Given the limited resources Elliott had available in the 1930's and 1940's, especially compared to today, it is also possible that he may not have been able to observe and document all the possible patterns. Nevertheless he was exceptional in observing these patterns, when nobody else did.

Prechter's counts have been so wrong time and again, I am highly skeptical of what are purely his observations and were not originally proposed by Elliott.

From the examples above, it looks like when waves 1 & 4 overlap, subwaves 1,3 & 5 can all be zigzags and also be all 5-wave impulses. So the subwave structure appears immaterial when overlap occurs. 

What causes waves 1 and 4 to overlap, remains an open question.

This will be a work in progress, and this page will be updated periodically with new observations and examples.

1 comment:

  1. Hi
    can we count wave 4 if shadows of wave 4 overlap to price territory of wave 1 but do not close into it?