4.49 Impulse Waves in 5-3 Wave Pattern

 
As mentioned in the previous chapter, we could classify Elliott’s theory into two parts:
 
The study of impulse wave.
The study of corrective wave.
 
In this chapter we will be talking about the impulse wave. An important point to note here is that there is an overall impulse wave, which is also called motive wave and then there are impulse waves of lower degree under, both, the impulse wave and the corrective wave.
 

Overall Impulse Wave Pattern

 
As you have seen in the last chapter, impulse wave is made up of 5 waves whereas corrective wave are made up of 3 waves.
 
Impulse wave in the 5-3 wave pattern in Elliott wave theory. 
 
We’ll look at impulse moves first. In a bullish market the impulse move comprises 5 moves that, in sum, take the market higher. In a bearish market the impulse move is made up of 5 moves that take it down. See, like this:
 
OK, so what’s happening in the markets when these waves are playing out? 
 
Remember: ‘Collective trader’ psychology’ from the first chapter on Elliott stuff? That’s what. So let us take you through a blow-by-blow account of the impulse wave story! Here goes.
 
Stages of the "Impulse Wave" showing the psychological aspects. 
 
The above diagram is self-explanatory but let’s again see what’ happening:
 
As usual the market is driven by the following types of traders:
 
  1. Smart money i.e. the money invested by traders with expert knowledge and experience. We can call these the guys who lead the market.
  2.  

  3. Followers or follow-up buyers and sellers who enter or exit the market based on the moves caused by the big and expert traders. This category includes traders with moderate knowledge & experience as well as novice traders.
  4.  

  5. Whatever is the type of traders; there are always traders with risk aversion and then those with higher risk appetites.
 
Let’s take the example of an impulse wave during uptrend. The opposite will be true during a downtrend.
 
  • The first wave of the impulse wave is mainly caused by the expert traders who also happen to have a good insight of the market. When they feel that the stock, currency or any commodity in question is undervalued, they stay buying. 

 

  • Some of these traders will either have less risk aversion to start booking the profits early or they, on purpose, sell off some of their portfolio the bring the price down so that they can buy again at lower prices. This sell off brings some correction to cause wave 2 of the impulse wave.

 

  • Wave 1 had caused some stir in the market and had opened the eyes of other traders who were keeping away. These traders not act or react and start entering the market. This rush combined with the fresh buying of the original group of big traders cause a long and strong upward jump. This turns out to be wave 3 of the impulse pattern. Please note that this wave is never the shortest one out of 1, 3 and 5 as the volumes traded are quite high.

 

  • Wave 4 brings another correction in the prices on some profit booking. However, Wave 4 is generally a short corrective wave as even though some of the traders start booking profits but then there are a lot many who have been waiting to enter the market on any correction. 

 

  • Wave 5 is the climatic one. The overall strong gains from the starting point till now causes a lot of media coverage and ridiculous forecasts. The general public and so called too safe traders wake up and start buying. However, the experts know that market might be overvalued and hence they are just waiting to exit. And that exit comes when a lot of profit booking takes place and the prices go south in a major correction. This brings the second phase of the 5-3 pattern, which we will discuss in the next chapter.
 

How to trade the impulse wave?

Impulse wave on a Forex chart.
 
As we had quoted from a book that Forex market, on an average, see the Elliot wave theory working 50% of times, let’s use that figure in a different way. As a retail trader, with limited insight of the market, you will not know when a particular sub-wave of the Impulse wave will start. In that case, if you make an entry somewhere during wave 1, it is better to stay in the market, without worrying about wave 2’s correction. You may look forward to exiting somewhere during wave 3. If the risk appetite is more then you may even ignore wave 4 correction and target to exit once the wave 5 starts and reaches 75% of the height of wave 3. 
 
The other way to use the impulse 5-wave pattern is to plan your entry or exit, considering that the theory will work, when you are trading based on any other technical indicator or trend-lines or price channels etc.
 
Also as we had mentioned in the previous chapter, we extend the wave theory a bit more by saying that even if there is no trend and the market is running sideways, try to keep the 5-wave limit in your mind to expect a possible breakout.
 

Sub-Impulse Waves

 
As we have seen, in 5-3 wave pattern the set of first 5 waves is termed as impulse wave or motive wave. However, as the term goes for the waves in the direction of the ongoing trend, the sub-waves 1, 3 and 5 are also termed as impulse waves. We can always consider them as impulse waves of a lower degree. Similarly during the later phase of 5-3 wave pattern, when the prices go for a major correction in 3 waves, the 2 waves in the direction of that correction are also, often, called as impulse waves.
 

 

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