Truncated fifth wave. “The Black Swan”

Truncated fifth waves are among the trickiest patterns in the catalogue of the Elliott Wave Principle. The worst about them is that you cannot predict a truncation. You can only guess, but the fact that a truncation may occur once in a hundred times makes guessing pointless. In this article we will use USD/JPY as an example to explain how you should prepare, think and reason in case of a truncated fifth wave. On the first chart below you can see an impulse with a missing fifth wave.

Recommended reading: Elliott Wave Patterns

truncated fifth 1

Normally in a regular impulsive wave, after the end of wave (4) you should expect prices to start rising again and wave (5) to exceed the top of wave (3).

truncated fifth 2

The above chart depicts that the bullish expectations were fulfilled and USD/JPY has moved significantly to the upside. In order to gain more confidence we look at the internal wave structure of this rise.

truncated fifth 3

What we see on the smaller time-frame is that the rally, which started when wave (4) ended is impulsive. Our chain of thought here is as follows: the top of wave (3) is still above current levels. => truncations occur once in a hundred times. => this must be wave 1 of wave (5), not the whole wave (5). So, going with the highest probability, we assume there is still room for USD/JPY to go north. The chart below shows how the forecast looks from that perspective.

truncated fifth 4

In other words, we are expecting a small correction in wave 2 of (5) and more strength after it. The invalidation level here is the bottom of wave (4).

Recommended reading: Where the protective stop should be?

Every trader has experienced that feeling of a stop-loss being hit. That is exactly what happened on the next chart.

truncated fifth 5

It is also our point of recognition, when we realize that one of the rarest patterns just materialized in front of us. A truncated fifth wave. Its wave structure is the same as in a regular fifth. The only difference is in its size. It is too short and does not reach the top of wave (3). So the right labeling from now on looks like this:

truncated fifth 6

That is why we had our protective stop there. As Nassim Taleb puts it, “to protect against the black swan”. Or as Goldman Sachs CEO Lloyd Blankfein says “given enough time, very low probability events not only can happen, but they absolutely will happen”.

New to Elliott Wave?

Elliott Wave principle offers a completely new understanding of what the nature of the markets is, what drives them and what can be derived from their movement. This course is for those of you, who have been looking for an honest Elliott Wave guide, describing the method’s advantages over other trading tools, but not hiding its weaknesses.

Check Video Course    or     Check our eBook


See our Video Course
or check our eBook

Last year over 60k readers trusted EWM Interactive to help them in their trading decisions.

I’m very happy i discovered your service. Thanks so much and keep up the good work!

- Xavier N.

Just loving your analysis. Thank you so much, really wished you add some more currencies to your list You have a client for life :)

- J. Kotzee

I love the way EWM does business: response times & overall friendly demeanor are fantastic... and the prices are very fair. The trade recommendations read like like they come from a seasoned trader that is used to winning. Couldn't ask for more.

- C. Montgomery

I love the way EWM does business: response times & overall friendly demeanor are fantastic... and the prices are very fair. The trade recommendations read like like they come from a seasoned trader that is used to winning. Couldn't ask for more.

- C. Montgomery

I’m very happy i discovered your service. Thanks so much and keep up the good work!

- C. Montgomery

Just loving your analysis. Thank you so much, really wished you add some more currencies to your list You have a client for life :)

- C. Montgomery