Faces of Waves Illustrated [4] - Impulse wave (1)

If you are new, check the introduction and table of contents first.

The first wave pattern I describe in details is impulse wave. Fortunately, this is the most important wave pattern we learn. It also have the most distinct shape, so we can easily identify.

I will describe impulse wave focusing on the following points:

  1. Anatomy: How does it look like? What is the subwave structures.
  2. When does it appear? How to anticipate the next impulse wave?
  3. What is the trading strategy over impulse waves?
  4. Using Fibonacci (golden ratio) to estimate the potential profit.
  5. Variation in the impulse structure: extension & truncation.

Probably, it would take three articles to finish presenting all the materials above.

1. Anatomy: How does it look like? What is the subwave structures.

The image below shows how impulse waves look like:

impulse-wave

Impulse wave is in the motive wave group. So an impulse wave must follow the rules of motive wave that I already described in the previous article. I list them again for your reference:

  1. Wave 2’s end point must not go beyond Wave 1’s start point
  2. Wave 3’s end point must go beyond the Wave 1’s end point
  3. Wave 4’s end point must not go beyond Wave 2’s end point

There are additional rules a wave must follow to be qualified as an impulse wave. They are:

  1. Wave 3 must be an impulse wave
  2. Wave 3 must not be the shortest among 1, 3 and 5 waves.
  3. Wave 4′s end point must not cross Wave 1′s end point. In other words, Waves 1 and 4 never overlaps in the price range.

That is it. These three additional rules make impulse wave look clearly pointing up or down, and it is easy for us to recognize the wave. As long as a impulse wave meets those rules, it can have variations in the shape as I illustrated on the right side of the image above. (I will describe the variations of impulse wave in coming articles.)

Now let’s look deeper into the substructure of the impulse wave. The next image shows the subwave sequence within an impulse wave:

impulse-substructure

As you can see,

  • Wave 1 must be a motive wave, and it can be diagonal or impulse. Appearance of a diagonal wave is rather rare here.
  • Wave 2 must be a corrective wave. A zigzag wave frequently appears in Wave 2, but it could be other corrective wave.
  • Wave 3 must be an impulse wave.
  • Wave 4 must be a corrective wave. We often observe a complex wave.
  • Wave 5 must be a motive wave. Either impulse or diagonal. Often we see a diagonal wave here.

And here is an example from real market:

20090922_eurusd_15min_impulse

It is very important to remember the subwave sequence in impulse wave, for a few years to a decade boom in the market often follows this impulse wave pattern. The market psychology at each wave is often described like this:

  • Wave 1: The bull market is emerging under the surface, but most people are still skeptical of the economy and desperate.
  • Wave 2: A zigzag but deep pull back falsely convince people of the continuation of the bear market. But it is actually the phase that the market charges energy for the strong bull market.
  • Wave 3: All of a sudden, the market gains upward momentum, and it only accelerates. The emergence of the bull market is now obvious to everybody.
  • Wave 4: Profit taking. The fortunate people who entered the market early enough start to cash out (sell). But there are still plenty of buyers, and the market goes sideways as a result of the tug of war between buyers and sellers.
  • Wave 5: Sellers at Wave 4 failed to change the course of market as the late participants rush to the market. The buying momentum overcomes the selling, sending the price even higher. Almost everybody is bullish about the market, and it becomes a mania. Only a few notice that the bull market is actually ending. (and the careless people lose their fortune in the bear market that follows)

I think I covered plenty in this article, so I will leave the remaining materials in the late articles. But before concluding, let’s go back to Wave 3 rules of impulse wave:

  1. Wave 3 must be an impulse wave
  2. Wave 3 must not be the shortest among 1, 3 and 5 waves.

So when we count the waves, we have to be careful not to break those rules. In the example below, the wave count on the left is incorrect because Wave 3 is the shortest. The right one is the same wave as the left, but with the correct wave count. Notice the use of subwave counts that makes Wave 3 itself an impulse. This agrees well with the rule No.2.

wave3-must-be-longest

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