The currency market corrects more than it trends. This means that an investor using the Elliott Waves Theory to count waves is mostly dealing with corrective waves rather than impulsive waves.
The market can either form a simple or complex corrective move; for any market swing, investors must decide if the move is impulsive or corrective. Investors use letters to label the waves.
All corrective waves, simple or complex, are called “threes” or “three-wave structures”, even if the actual number of waves is sometimes larger than three. The term “threes” refers merely to the corrective nature and is the key difference between a corrective and impulsive wave.
Elliott found three types of simple corrections.
1. Flat patterns
A flat pattern is a three-wave structure with two corrective waves and one impulsive wave. Labelled a-b-c, only the c-wave is impulsive and follows all the rules of an impulsive wave as explained in a previous lesson in this course.
The key to a flat pattern is the b-wave’s retracement; it must retrace at least 61.8% of the previous a-wave. Flat patterns are the most common type of corrective waves, and we will look at them in more depth in a future lesson.
A zigzag is another three-wave structure which has two impulsive waves. Also labelled a-b-c, the a-waves and c-waves are impulsive, and only the b-wave is corrective.
Like a flat structure, the b-wave’s retracement is also critical here but, unlike the flat, it retraces less than 61.8% of the previous a-wave, so the a-b-c structure has zero meaningful retracements.
By far the most common corrective structures, triangles almost always form on every timeframe. When the market expects a correction, chances are a triangle is at least part of the corrective structure.
Despite having five segments, a triangle is said to be a three-wave structure, because all its segments – a-b-c-d-e waves – show corrective activity, hence the “three” name.
A triangle rarely appears as a simple correction. If it does, it can only appear on the 4th wave, and not the 2nd wave. A triangle can also form on the b-wave of a zigzag. However, most of the time a triangle appears as part of a complex correction. As you’ll find out later in this course, a complex correction never starts with a triangle, but it almost always ends with one.
- In a flat the b-wave retraces at least 61.8% of the previous a-wave.
- In a zigzag the b-wave retraces less than 61.8% of the previous a-wave.
- All corrective waves are called “threes” despite some having more than three segments.
- Corrective waves can be simple or complex.
- Triangles are most likely to be found in complex corrections.