There are three main false warnings' areas. These are the first "Elliott wave", the third Elliott wave and the fifth Elliott wave.
The first wave.
According to the market patterns (not price pattern), "the market" moves up or down then pauses before resuming another move. The market patterns are trend, consolidation and trend. Besides these, the first impulse is the move that breaks out of the consolidation region. Before the breakout, no one knows for sure, where the financial asset will be heading. The first thrust is usually a surprise move and a powerful one. Many momentum indicators at this stage lag. Most will fail to catch up with the price's surge. This omission creates false warnings or distorts many indicators. "MACD", "RSI", "CCI", ROC, and the slow "stochastic" will fail to reflect the sudden surge in momentum and volatility.
This lagging phenomenon is the cause of many false disparities during the first move. The price displays the first higher low or lower high, but these indicators indicate false bullish or bearish disparity at the beginning of a new trend. The rapid momentum and volatility's transformation, and break out move engender visible distortions and false advices. Traders who trade indicators instead of the price itself may lose because of these false indications.
The third wave.
The third wave is an impulse move or a trending phase. It is essential to understand that a false divergence is the result of lagging indicators. The price is the number one "indicator". Traders should keep their eyes on the price. Indicators are useful, but they only give warnings. There are three things, traders should learn to understand:
1/ the warning,
2/ the signal (given by the price itself),
3/ and the entry point (entry time frame).
Similarly to the first thrust, unconfirmed and unfunded warnings take place in the third "Elliott" stage. The two main reasons are distorted and lagging indicators, missing the point or failing to act in tandem with the financial asset. Equally, many traders do not understand these indicators therefore, misinterpret their indications. Trading "tools" do reset themselves after a wild departure from their fair value or after failing to display an earlier price's motion. During the third impulse, the velocity is immensely strong as the price is trending. This vertical or diagonal move leads to incorrect readings if one is "trading" the "trading tools" instead of the price.
The third impulse is a trending period so; traders should apply trending trading systems. MACD which is a trending "indicator" delivers excellent confirmations during the third phase.
The fifth impulsive action.
Though strong "divergence" does often take place in the fifth phase, false warnings do exist also. Apart from the already stated causes in the first and third wave, there is another phenomenon. It is the fifth wave extension. It is not possible in this article to analyse the perfect wave extensions ideas. However, one should remember that, due to the fifth impulse's extension, many momentum indicators usually fail to confirm the extension, thus giving wrong signals. At the end of the fifth wave, "the market" is considered overbought or oversold, but one should wait for a strong signal after the market is truly overbought or oversold. Whatever trading "tool", one is using one should confirm all disparity signals by the price itself without rushing or cutting corners.
False signals are repeated in the first and third wave. However, they are less frequent in the fifth wave. The understanding of the market patterns, the price patterns and the meaning of an up trend or downtrend can help traders in avoiding this unpleasant trading. It is quite difficult to escape the "Elliott wave" theory; on the contrary, its consideration will allow traders to discern patently erroneous divergences. In all cases, one must use the five per cent money management rules without neglecting basic "trading" rules. This article is for educational purposes only.
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