Elliott Wave theory can be rather complex for those starting out in technical analysis, but learning Elliott Wave basics can really help your trading. This the first in a series of articles will look at the most essential concept of Elliott Wave theory, an element that isn’t complex. This is a concept that every trader can use, understand, implement, and arguably needs.
Elliott Wave Basics: Impulse and Corrective Waves
Even if you never delve further into Elliott Wave theory, the concept of impulsive and corrective waves will aid your trading. These two types of waves create the overall market structure, and therefore being able to tell the difference between them is the difference between taking high probability trades or low probability trades.
An impulsive wave is what allows trends to exists. It is a sustained move in one direction with most of the price bars all moving in that one direction.
A correction is a smaller move which occurs in the opposite direction of the impulse.
Figure 1. Impulse and corrective waves
In Figure 1 the price scale and time scales have been deleted, since the focus is “relative” price action. The impulse is a strong move, of larger magnitude than corrective waves. In Figure 1 there is an upward impulse followed by several corrective waves. The corrective waves are smaller than the impulse.
Elliott Wave Basics: Trading with Waves
Since the impulse was to the upside, this is the direction to trade. The impulse shows the direction of current momentum. Impulses create trends, therefore, we want to enter on corrective waves and ride impulsive waves.
Since figure 1 shows a strong impulse wave to the upside, the correction provides an entry into hopefully another impulse wave higher.
Trends are composed of several impulse waves and a few corrections. Figure 2 shows how this unfolds.
Figure 2. 5 Wave Price Pattern
Quite often asset prices follow a 5 wave structure, where there is an impulse wave which starts the trend, corrective waves, an impulse, corrective waves and then a final impulse. Correction have been circled, and as you can see are often (but not always) composed of several corrective waves, all of which are smaller than the prior impulse.
Each wave is given a label, but at this point, labeling is not important. While this is the basic guideline, without developing further into Elliott Wave analysis you’ll quickly find that some trends have many more waves than 5, and sometimes less (such as 3). Therefore, don’t concern yourself with how many waves a trend has. Just trade in the direction of the impulses (some warnings signs of a reversal are given below).
A one-minute chart of the EUR/USD during the London or US session will often see trends of 7 to 11 waves.
Figure 3. Nine Wave Trend and Potential Reversal (main impulse and corrective waves marked with lines)
Figure 3 shows a 9 wave trend, composed of 5 impulse waves down, interspersed with 4 corrections. While the corrections sometimes have multiple gyrations (or small waves) notice how all the waves in the correction are smaller than the impulsive waves. That says the trend is still in tact and we want to trust in the direction of the impulse waves. Also see: Analyzing Price Action: Velocity and Magnitude.
After the 9th wave (bottom of chart) there is a strong move higher, and it breaks the high of the last corrective wave. This is an impulse wave in a new direction, and says that the downtrend may be over. We know it is an impulsive wave because it was larger than the last impulse down.
That is all well and good, but how do ranges fit into this? Price ranges, and other chart patterns such as triangles, are simply more complex corrections composed of many corrective waves. If you change your timeframe you’ll likely see the range or triangle is just part of a larger impulse, correction, impulse…structure.
You can also compare the current impulse to prior impulses to gauge the strength of the trend. In Figure 3 the last impulse wave down barely makes a lower low before stopping and then moving higher in a potential corrective wave (which turned into an impulse higher). That final impulse lower was smaller than the prior impulse waves which had no problem moving the price down to lower and lower levels. Therefore, that small impulse wave near the bottom of Figure 3 indicated the downtrend may be out of steam, and a reversal–which did occur–was probable.
- Fibonacci Retracements can help you find entry points in corrective waves/corrections,
- Fibonacci Extensions can help you isolate where to take profits during the next impulse wave.
Elliott Wave Basics: Final Word
Prices move in a structured way: impulse, correction, impulse, correction, impulse, etc. Sometimes when this structure isn’t clear, it helps to switch to a longer time frame. This will allow you to see if the asset is possibly within a larger complex correction pattern (a combination of corrective waves) which is why the structure is not very clear on the time frame you were watching.
Trade in the direction of the impulses until there is a reason not to. Reasons to avoid trading in the direction of the impulses include:
—Impulses are getting smaller and smaller, indicating lack of momentum and a possible reversal.
—An impulse in the opposite direction occurs, which means you’ll start looking for trades in the direction of the new impulse.
This does not necessarily mean you are in a trade at all times, and want to trade every price swing. If the price structure is not clear, step aside until it is. This wave structure appears on every time frame, so impulse waves higher on a one-minute chart, may be corrective waves against a downtrend on a five or 15-minute chart. This shouldn’t scare you away from trades on your time frame, but try to maintain some perspective on where you are taking trades relative to the trends and corrections visible on other time frames.
No wave counting or complex theories are needed. Identify impulsive waves by their strong movement, and corrective waves by their relatively smaller movements.
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