The Elliott Wave theory is one of the most fascinating concepts in technical analysis, claiming that its cycles depict human sentiments like optimism and pessimism.
The Elliott Wave Theory is made up of impulsive and corrective waves. In fact, this is the first decision an investor must make: whether to label a market swing as impulsive or corrective.
What makes a move impulsive
An impulsive wave, or move, is a five-wave structure which is always labelled with numbers. Investors look for market actions and reactions and label them accordingly.
Interestingly, even in an impulsive move, there is corrective activity; namely, wave 2 and wave 4 in an impulsive move are corrections.
In an impulsive move, the market must respect all the following conditions:
- Wave 1 is always an impulsive wave.
- Wave 2 is corrective and cannot fully retrace wave 1.
- At least one wave must display an extension.
- An extension is defined as a minimum 161.8% of wave 1, projected from the end of the previous corrective wave.
- Wave 3 must have impulsive characteristics.
- Wave 3 is never the shortest.
- Wave 4 is corrective and typically retraces 38.2% of wave 3.
- There must be no overlapping between waves 2 and 4.
- Wave 5 is impulsive.
Types of impulsive waves
If any of the above rules are not followed, the move cannot be called impulsive. Because no alternative exists in the Elliott Wave Theory, the move is consequently considered corrective. Therefore, the purpose of the Elliott Theory is to indicate whether a move is impulsive or not; if not, it is then considered a corrective move. Alternatively, Elliott Theory can be used to indicate whether a move is corrective; if not, it considered impulsive.
Depending on the extended wave, three types of impulsive waves exist:
- Wave 1 extension – wave 1 is the longest in the structure.
- Wave 3 extension – wave 3 is the longest wave.
- Wave 5 extension – wave 5 is the longest wave.
Rarely, the market may form a double extended impulsive wave, but this is not worth discussing because it infrequently appears on the currency market.
Out of the three types, the wave 3 extension is the most frequently occurring, followed by the wave 1 extension. A wave 5 extension is not a common occurrence on the currency market.
Below, we can see what an impulsive wave looks like and how it is labelled:
As we can see, wave 3 is the longest, therefore this is a wave 3 extension impulsive move; the most common type of impulsive wave.
- An impulsive wave is a five-wave structure labelled with numbers.
- Three types of impulsive waves exist.
- The extended wave is longer than 161.8% of the next longest wave.
- Wave 3 is not the shortest.