The Impulse Waves

Elliott Waves

The Impulse Waves - Text Version

Welcome to our module on Elliott Waves!

In this course, we are going to break down the main principles behind Elliott Waves, so you can begin applying it to charts and have a foundation for further study.

The Elliott Wave Principle begins with a simple idea: that markets are not random or chaotic in nature, but instead unfold in specific trends or patterns.

Ralph Nelson Elliott, the founder of Elliott Wave Theory, noticed that prices make five swings in the overall direction of the larger trend and then typically three swings against it. Elliott called those swings “Waves”. Together, the 5-Waves in the direction of the trend followed by the 3-Swings against it is known is known as a full Elliott Cycle.

Understanding that the markets are made up of cycles which can be broken down into specific types of waves is very useful when looking at any chart. It helps you find context in the current market action and gives you a guide for where potential turning points may happen.

Let’s begin by looking at the initial Five Wave Pattern.

This diagram shows a Bullish Five-Wave pattern, but all the same rules apply if the Five Wave pattern is Bearish.

Elliott very helpfully labelled the five Waves as Waves One, Two, Three, Four and Five. To avoid confusion, Elliott Wave practitioners always place the label for each wave at the  end point of the wave, never in the middle or at the beginning of the wave.

Waves One, Three and Five all move in the direction of the overall trend. These waves are known as “Motive Waves” as they powerfully drive the market. The notable Elliot Wave 5th wave characteristic is that it must be shorter than Wave 3, but can be longer than Wave 1.

Waves Two and Four move in the opposite direction to the overall trend and they are known as “Corrective Waves” as they partially correct or retrace the market.

Together, the Five Wave structure is called the “Impulse Wave”.

When you are looking for a 5-Wave pattern on a chart, there are 3 main rules you must observe for the pattern to be a valid Elliott Wave Impulse sequence.

Rule 1: The end of Wave 2 cannot go past the start of Wave 1.

Rule 2: Wave 3 cannot be the shortest Motive Wave. That means either Wave 1 or Wave 5 (or even both) must be shorter than Wave 3. Very often, Wave 3 is the longest Motive Wave, but that does not necessarily have to be the case. It just can’t be the shortest.

Importantly, when we say “shortest” or “longest” we are talking about how much price action is covered, not the amount of time it takes for the Wave to form. That means on a Forex chart, Wave 3 must cover more pips than either Wave 1 or Wave 2. Sometimes, Wave 3 can be the quickest wave in terms of time.

Rule 3: Wave 4 cannot go into the price territory of Wave 2. That means Waves 2 and 4 must have some clear separation of price action or pips.

Elliott Wave Theory states that the Waves are [emphasize next word “Fractal” in nature. That means the pattern is the same at different scales and it is  self-repeating. For example, a lower timeframe chart such as a 1-minute chart will show the same Elliott Wave structure as a higher timeframe such as a Daily chart. The fractal nature of Elliott Waves means that Waves of a larger degree are subdivided into waves of a smaller degree. If you looked at a 5-Wave impulse sequence on a Daily chart, Wave 3, for example, would show its own 5-Wave pattern on a smaller timeframe, in this case a 4-Hour or 1-Hour chart.

How does a typical 5-Wave impulse sequence subdivide on a smaller scale? In Elliott terminology, the smaller subdividing waves are known as Waves of a “lesser degree”. Each Motive Wave has Five waves of a lesser degree and each of the Corrective Waves usually has 3 waves of a lesser degree.

In this lesson we have covered the some of the key foundations of Elliott Wave Theory and had a close look at how an Impulse Sequence is formed. In the next lesson we are going to look at some charts and mark our own Elliott Wave counts for a complete 5-Wave Impulse sequence.

Get ready to start applying the theory on real charts!