Wave 4 Rule
The Wave 4 rule states that in an impulse wave, Wave 4 cannot enter the price territory of Wave 1. In a bull market, the low of Wave 4 must stay above the high of Wave 1. In a bear market, the high of Wave 4 must stay below the low of Wave 1. This is the third absolute rule in Elliott Wave analysis, and it has only one exception: diagonal patterns, where overlap between waves 4 and 1 is permitted. This rule is your real-time validation tool during trending markets. As Wave 4 unfolds, you know exactly where the invalidation line sits. If Wave 1 topped at $50, then Wave 4 cannot drop below $50. A break below that level means you are not looking at an impulse wave and need to reconsider your entire count. The rule exists because impulse waves represent strong directional moves. Overlap between Wave 4 and Wave 1 would indicate weakness inconsistent with impulsive price action. Traders use this level as a stop-loss placement zone for positions entered during Wave 4 with the expectation of catching Wave 5.
Amazon rallies from $140 to $160 in Wave 1 (Wave 1 high is $160). Wave 2 corrects to $148. Wave 3 rallies to $210. Wave 4 begins correcting. You know the absolute floor for Wave 4 is $160, the Wave 1 high. Price drops to $188, then $175, then finds support at $168. Each dip tests your nerves but stays above $160. You hold your long position with a stop at $159. Wave 5 launches from $168 to $235. If price had broken below $160, you would have exited knowing the impulse count was invalid and something more bearish was developing.