Faces of Waves Illustrated [5] - Impulse wave (2)

This is the second article on impulse wave. Today I describe…

2. When does it appear? How to anticipate the next impulse wave?
3. What is the trading strategy over impulse waves?

2. When does it appear? How to anticipate the next impulse wave?

If you recall the previous article, one of the rules of impulse wave says,

  • Wave 3 must be an impulse wave

So, it is obvious, you should look for 3rd wave of impulse to locate smaller impulse wave.

Other places you could anticipate impulse waves are:

  • 1 and 5 waves in motive waves except for ending diagonal (I will explain what the ending diagonal is in coming article)
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  • A and C waves in zigzag
  • C wave in flat

I have not explained details of waves other than impulse, and you will understand better about whereabouts of impulse wave after you will learn every wave patterns. For now, this figure may help you:

locating-impulse

The bold green lines indicates the sub-waves in each wave pattern where you can anticipate an impulse wave.

Example: Suppose you have just seen a beautiful upward impulse wave followed by a corrective wave of any type downwards, and we want to guess what is the type of the wave of one greater degree. Looking from above picture, we know it is either impulse, diagonal, or zigzag. Conveniently, in either scenario, the wave that comes next is motive and it is often impulse because:

  • In case of impulse the next wave is either Wave 3 or 5. If it is Wave 3, it will be an impulse. If it is Wave 5, it is any of motive.
  • In case of (leading) diagonal the next wave is either Wave 3 or 5, and both are to be motive and potentially impulse. (I will explain what “leading diagonal” is in the coming article.)
  • In case of zigzag, the next wave is Wave C that is to be motive and potentially impulse.

The example above is very simple scenario, and it takes the understandings of the substructures of other wave patterns (so far we only studied impulse) in order to make our prediction more accurate. We also should zoom up and down to the waves of one greater or lesser degree to grasp the whole picture and check there is not a contradiction. It’s just like we start looking at whole mountain first, then to zoom up to woods, then to a single tree, or vice versa.

Our study so far gave a vague idea when to anticipate an impulse wave, which may or may not come. But it gave much clearer idea when NOT to expect an impulse wave. The number of sub-waves in the six wave patterns (impulse=5, zigzag=3, …) in the figure is 32. The sub-waves marked with the green lines are only 9. So, if those six wave patterns are present in the chart, we know that we should not be trading at all for 62% of the time. Some novice traders buy and sell restlessly with no discipline only to lose money. But with the help of Elliott wave principle, we know when we should refrain from trading and just stay back to see where the market goes.

3. What is the trading strategy over impulse waves?

While knowing exactly where we are on the wave patterns takes further study and practice on the real charts, it is still true that you could anticipate the appearance of an impulse after you have just seen a impulse-corrective sequence. So, I think it is exciting and beneficial to introduce a trading strategy on impulse wave.

impulse-trading-idea

Phase (a) Suppose we think there are a chance for an impulse wave to appear next. The sub-wave 1 (black 1 in the above figure) of coming impulse is a motive wave followed by sub-wave 2 (black 2) that must be a corrective wave and it is often a zigzag. So we wait to see if those two sub-wave sequence will appear as we anticipate…and they did! We are even more convinced that we are at the beginning of the impulse wave. We also anticipate the next sub-wave to be Wave 3 that is also an impulse wave of the lesser degree.

Phase (b) We wait again to observe sub-sub-wave i and ii. The next one is sub-sub-wave iii, and once sub-sub-wave iii  takes off, it should not come back down lower than the end of ii. We buy as sub-sub-wave iii overcomes the peak of sub-sub-wave i (the first green star in the figure).

Phase (c) and (d) Now we have two scenarios:

  • Success scenario. We can exit the market at the end of sub-sub-wave iii, or we can go all the way to the end of sub-wave 5 (blue circles in the figure).
  • Failure scenario. What we thought to be sub-sub-wave iii goes below the end of sub-sub-wave ii before extending the gain. This means this was not an impulse wave, and we pay for what we judged wrong.

Yes, we may fail. We always have a chance to fail and take a loss.

The most important thing in this strategy is that we know the exact cost of the failing scenario by the time we establish the position: The loss is about the difference of the entry price level and the price at the end of sub-sub-wave ii (shown as potential loss in the figure). It is crucial in trade, especially when you use leverage, that we are disciplined enough to exit the market as soon as the price action breaks the rules of Elliott wave.

It would be also helpful if we can estimate the potential profit (reward) besides the potential loss (risk). A clear risk:reward ratio would help us to decide how much of the capital we expose to the risk. One way to estimate the potential profit is to use golden ratio or traders often call Fibonacci, and it is the topic that I am going to write in the next article.

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