In Elliott Wave Theory, there is an important distinction between **rules** and **guidelines**. Guidelines describe what usually happens. Rules describe what always happens. Breaking a guideline means an unusual pattern — but breaking a rule means the wave count is simply wrong. There are exactly three rules in Elliott Wave that can never be broken. If any of them are violated, the analyst must relabel the entire wave structure. Understanding these rules is the single most important skill for any Elliott Wave practitioner. ## Rule 1: Wave 2 Never Retraces More Than 100% of Wave 1 After Wave 1 completes, the market pulls back in Wave 2. This correction can be deep — sometimes retracing 61.8% or even 78.6% of Wave 1. But there is an absolute limit: **Wave 2 can never take prices below the starting point of Wave 1.** Why? Because if the market drops below where Wave 1 began, then Wave 1 is not Wave 1 of an impulse — the entire structure needs to be reinterpreted. **Practical implication for NEPSE traders:** If you believe Wave 1 of a new bull market began at a particular low, and the market subsequently drops below that low, the count is invalid. The rally was either a corrective bounce in an ongoing downtrend, or the wave degrees are different from what you thought. This rule protects traders from prematurely labeling a new bull market. ## Rule 2: Wave 3 Is Never the Shortest Among Waves 1, 3, and 5 Of the three actionary waves in an impulse (Waves 1, 3, and 5), Wave 3 must travel farther than at least one of the other two waves. It does not have to be the longest wave — Wave 5 can be the longest if Wave 5 is the extended wave — but Wave 3 can never be the shortest. In the vast majority of cases, Wave 3 is the longest. It is the most powerful, most recognizable wave. But in markets where Wave 5 extends (common in commodity markets), Wave 3 need only be longer than Wave 1. **Practical implication for NEPSE traders:** If you have counted five waves and the middle wave (Wave 3) is the shortest of the three advances, your count is wrong. You may be looking at a diagonal triangle, a corrective wave, or simply an incorrect labeling. Recount. ## Rule 3: Wave 4 Never Overlaps Wave 1 Territory In a standard impulse wave, the price range of Wave 4 must never enter the price range of Wave 1. In a bull market, this means the low of Wave 4 must remain above the high of Wave 1. This is the overlap rule, and it is what distinguishes an impulse wave from a corrective diagonal triangle (where overlap is permitted and expected). **The single exception:** In highly leveraged futures markets, brief, intraday violations of this rule occasionally occur. But in the spot equity market — like NEPSE — if Wave 4 overlaps Wave 1 in daily closing prices, the count is invalid. **Practical implication for NEPSE traders:** The overlap rule is perhaps the most useful in real-time analysis. If you are counting an advance as an impulse and Wave 4 drops into Wave 1 territory, one of two things has happened: either your count is wrong and the advance is actually a corrective pattern, or you need to re-examine where the wave boundaries are. ## How These Rules Work Together The three rules work as a system. Consider a scenario: - You label an advance as Waves 1-2-3-4-5. - Wave 3 appears to be shorter than Wave 1. - **Rule 2 violated** — you must relabel. Most likely, what you labeled as Wave 3 is actually an extended Wave 1, and what you thought was Wave 5 is actually Wave 3 — still in the process of developing. This is one of the most common and important re-interpretations in real-time Elliott Wave analysis. ## Rules vs. Guidelines Once you have confirmed that no rules are broken, you then apply guidelines to determine the most likely scenario among valid counts. Guidelines include: the pattern of alternation between Wave 2 and Wave 4, the depth of corrections, Fibonacci ratio relationships, channeling, and wave personality. As Prechter and Frost wrote: *"A rule should never be disregarded. In many years of practice with countless patterns, the authors have found but one instance above Subminuette degree when all other rules and guidelines combined to suggest that a rule was broken."* ## Summary | Rule | What It Says | What Violation Means | |------|-------------|---------------------| | Rule 1 | Wave 2 ≤ 100% of Wave 1 | The advance is not a Wave 1 impulse | | Rule 2 | Wave 3 ≠ shortest motive wave | The count needs complete relabeling | | Rule 3 | Wave 4 ≠ overlap Wave 1 | The advance is corrective, not impulsive | Master these three rules and you immediately eliminate a large percentage of invalid wave counts — making your analysis far more reliable. --- *Sources: Elliott Wave Principle — A.J. Frost & Robert R. Prechter (1978); Elliott Wave Essentials — Robert R. Prechter, Elliott Wave International (2024). Translation available: click the language button above.*