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Characteristics of Impulse Waves

Elliott Wave Theory interprets market actions in terms of recurrent price structures obedient to the Fibonacci sequence. For every impulse wave, it can be sub-divided into 5 - wave structure (1-2-3-4-5).
  1. Wave 1


    Happens when the market psychology is practically bearish. Rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts. In a state of tranquillity, it usually demonstrates insignificant price moves in the background of general wavering.

  2. Wave 2


    This wave corrects wave one. It can roll back to almost 100% of Wave 1, but not below its starting level. This wave develops in the background of prevailing amount of investors preferring to fix their profits. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% of the wave one gains, and prices should fall in a three wave pattern.

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  1. Wave 3


    This is usually the largest (it can never be the shortest) and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. It is what the Elliott's followers live for. Rapid increase of investors' optimism is observed. Prices rise quickly, corrections are short-lived and shallow, and the volumes are also increased. Anyone looking to "get in on a pullback" will likely miss the boat. As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three's midpoint, the Prechter Point, "the crowd" will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1.
  1. Wave 4


    Often difficult to identify. It usually rolls back by no more than 38% of Wave 3. Its depth and length are normally not very significant. Optimistic moods are still prevailing in the market. Wave 4 may not overlap Wave 2 until the five-wave cycle is a part of the end triangle.

    Wave four is typically clearly corrective. Prices may meander sideways for an extended period. Volume is well below than that of wave three. This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, the most distinguishing feature of fourth waves is that they often prove very difficult to count.

  2. Wave 5


    Wave five is the final leg in the direction of the dominant trend (as represented by the impulses). It is often identified using momentum divergences. The prices increases at middle-sized trade volumes. The wave is formed in the background of mass agiotage. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high, the indicator does not reach a new peak). At the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock market during 2000 were received). At the end of the wave, the trade volumes often rise sharply.

Elliott wave

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