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When it comes to Elliott Wave Theory, you either understand it, or you don’t, there is no in between.
In the same way, those who understand it either find value in it or they don’t.
Having been a student of the financial markets since 2002, I can tell you I don’t subscribe to Elliott Wave principles, at least not in the full meaning of the term. It’s far too convoluted and ambiguous for my taste.
Don’t get me wrong; I’m not saying it doesn’t work. I’ve been around the markets long enough to know better than to speak in absolutes about what does or doesn’t work.
After all, achieving consistent profits as a trader isn’t about finding the best trading strategy, it’s about finding the strategy that works best for you.
But the truth is, as price action traders we use a portion of Elliott Wave every single day. You may not even know it exists, but it’s present in everything we do.
I’m referring to the notion of impulsive and corrective moves.
If you aren’t entirely sure what those are or how they can aid you in your trading, it’s okay. By the time you finish reading this lesson, you’ll know three simple yet effective ways to use these moves in combination with price action strategies to help stack the odds in your favor.
Let’s get to it!
First things first, to fully understand the meaning of impulsive and corrective waves, you need to know that every market ebbs and flows in harmony with daily events.
Those events include everything from the interest rates that are set by central banks to natural disasters.
The “ebb and flow” as it’s often called, is the visual representation of how markets respond to and sometimes counteract those daily events.
Why does this matter?
It matters because it’s what allows us as technical traders to buy at support and sell at resistance.
Think of the ebb and flow as the regular and often repeatable manner in which every financial instrument moves.
The more in tune you are with it, the more money you stand to make.
As much as I’d like to say it’s something that can come from a textbook, I can’t do that. Every profession, whether it be trading, medicine, law or any other desirable career has certain limitations as to the skills that can be acquired through written words alone.
The rest has to come from experience. In your case, screen time.
At the risk of sounding cliche, if you want to become a great trader you have to become one with the market’s ebb and flow. You need to eat, sleep and breathe price action until spotting trends, drawing critical levels and identifying favorable patterns becomes second nature.
Only then will you have the “x factor” necessary to achieve consistent profits.
The good news is that I can help. I can show you what to pay particular attention to while you rack up said screen time, and it all starts with a market’s ebb and flow.
Keep these points in mind as you navigate through the following sections. The material below is the foundation for every profitable trade ever taken, regardless of the strategy that was applied.
These are the moves or waves that best represent the direction of the current trend. During an uptrend, the impulsive moves are those that push prices higher. The opposite applies to a downtrend where the impulsive waves are those that drive prices lower.
These impulse movements are often made up of large candlestick bodies and are typically quite aggressive, especially compared to corrective moves.
Here’s an example of three impulsive bearish moves on the AUDUSD daily chart.
As you can see, these impulse movements are swift and aggressive. As such, these areas offer the greatest profit potential in the least amount of time.
But things aren’t always as neat and tidy as the AUDUSD chart above. In fact, more often than not these movements vary in size as well as angle.
Take the USDJPY weekly chart below as an example.
During an uptrend, these impulsive waves push prices higher in a relatively short period.
However, notice how the second rally above is much smaller than the other two. You could even argue that the entire middle section of the chart was corrective.
But as is the case with most topics in the Forex market, it’s somewhat open to interpretation.
In summary, impulsive moves within a downtrend are comprised of mostly bearish candles. Alternatively, impulsive bull moves, like the USDJPY chart above, are made up of mostly bullish candles.
On the opposite end of the spectrum, we have corrective moves or waves that work against the prevailing trend. These counter-trend moves represent a period of consolidation and are typically weaker and less aggressive than the impulsive waves we just covered.
A corrective move during an uptrend is characterized by a move lower or even sideways. Unlike impulse movements, corrections are formed by a mixture of bullish and bearish candlesticks where the bodies are relatively small.
Here is the same AUDUSD daily chart as above, only, this time, we’re focusing on the corrections.
Notice how the two areas above include a mixture of both bullish and bearish candles, a common trait of most corrective movements.
They also developed against the prevailing trend and at a less severe angle. These are telltale signs of corrective moves that have the potential to be continuation patterns. More on this later.
Next up is the USDJPY weekly chart we studied previously.
Just like the impulsive moves above, we can see that these corrections aren’t always uniform. They can take on various shapes and sizes, but what’s important is the meaning behind them.
Each area highlighted above occurred following extended rallies and moved at a less steep angle than that of the impulsive waves.
These characteristics signal that buyers were taking profit during these periods, thus creating a level of indecision that formed a pause in the uptrend.
In summary, corrective moves are typically comprised of a mixture of bullish and bearish candles. The same goes for both uptrends and downtrends.
What is it about the pin bar that makes it such a profitable candlestick pattern?
Is it how the candle forms or its location in context to the surrounding price action?
An argument can be made for both as the most profitable pin bars are distinct and also occur at key support or resistance.
But here’s the deal…
A perfectly formed pin bar in the middle of nowhere is useless. Sure, it may trigger a move, but it doesn’t have what we need for it to be tradable.
On the flip side, a decently formed pin bar at an obvious level of support or resistance can be extremely profitable.
Therefore, we can say that the location of a pin bar is more important than how the candlestick forms.
Here’s an excellent example of two well-formed pin bars that occurred at prominent levels in the market.
What made these two patterns work as sell and buy signals respectively are the levels at which they formed.
Sure, the pin bars are also perfect, but those same candles at arbitrary prices wouldn’t trigger the same favorable follow through.
While these were no doubt profitable setups, a ranging market isn’t always the best when looking for price action signals.
Why is that, you ask?
The lack of a directional bias creates uncertainty. For this reason, trade setups that occur within a strong trending market are almost always the better option.
With this in mind, it’s best to identify the trend first and then watch for bullish or bearish price action at key levels. By doing this, you’re able to leverage the momentum of the market to help ensure follow through once you’ve taken a position.
We can, therefore, say that the very best pin bars are the ones that occur at the end of a corrective move and form at support or resistance. The idea is to position ourselves to catch the next impulsive wave as soon as it begins.
Here’s an excellent example of one such pin bar that occurred on the EURUSD weekly chart.
Four factors contributed to the success of this bullish pin bar:
In summary, the ability to determine where a trend is in its lifecycle will allow you discover price action signals that provide follow through.
Using corrective moves to identify breakout opportunities has become my favorite method of identifying setups over the last few years.
Why is that?
It’s because a corrective move is nothing more than a market hitting the pause button.
This “pause” in the price action allows me to reassess the situation and determine whether any favorable patterns exist.
But there are a few choice technical patterns that work the best.
These include the bullish or bearish flag along with the wedge. And the great thing about using these formations, especially the bull and bear flag, is that they occur more often than you might think.
Again, it takes practice, but a Forex trader can easily make a living from trading nothing but flag patterns. In fact, I’ve met a few who do just that.
So why are these continuation patterns so lucrative?
Because joining an established trend takes half of the guesswork out of what we do as traders. You know the momentum is there which means all you have to do is find a favorable entry and profit target.
The momentum takes care of the rest.
Okay, let’s dig into a couple of examples to see how these corrections can offer a chance to join an established trend.
Do you remember the USDJPY weekly chart from earlier? Well, here is the first corrective move as it appeared on the daily time frame at the time.
The wedge pattern you see above offered an exceptional opportunity to get long following an extended corrective move.
Everything between support and resistance is considered consolidation and is, therefore, labeled as corrective within the broader uptrend.
And here is the second period of consolidation as it appeared on the daily chart.
Again, another wedge pattern that ultimately triggered a massive rally.
Note that in this case, the pair not only carved out a wedge pattern but also formed a bullish pin bar following the break from consolidation.
As such, we can call the chart above a blend of the first two strategies in this lesson.
You now know that the study of impulsive and corrective movements can lend itself to help you find favorable momentum plays.
But all trends, regardless of how healthy they appear, must eventually come to an end. It’s during these transitional periods that we can use the same concepts to discover reversal plays.
A reversal pattern such as a head and shoulders and its inverse are indications that a trend is tiring. In other words, they signal a potential change in sentiment and momentum.
Here’s an example of a topping pattern on NZDJPY that we recently traded.
After several weeks, the structure above provided us with a 1,000-pip profit.
But chances are you’re familiar with how to trade the head and shoulders pattern. What you may not know are the forces at work that make the formation profitable, namely how impulsive and corrective moves play a role.
So let’s view the same NZDJPY weekly chart from a different perspective.
What makes this pattern so lucrative are the forces at work behind the “head” of the structure.
Within this one swing high was the last impulsive bullish move as well as the first impulsive bearish move in over two years.
This first bear move gave rise to the first bearish corrective move, which is designated by the larger red area in the chart above. You can then see the steep decline that transpired immediately following the break below neckline support.
Now, because we’re studying the ebb and flow of a market rather than technical patterns, it’s important to keep in mind that reversals come in all shapes and sizes. They aren’t always a clear head and shoulders, double bottom, etc.
Take the USDCAD daily chart below. Here we have a bullish pin bar/rejection bar that formed at new support. This formation came after the pair carved out its first impulsive bullish move in several months.
This particular setup was one that was covered here at Daily Price Action and also traded by several members.
So what made me think this level would hold?
The fact that it had already played a significant role over the previous twelve months was a good starting point.
But it didn’t end there. The recent rally from a multi-month low looked impulsive, at least compared to the other corrective moves of late.
Notice how the rally in blue occurred at a much steeper angle and for a longer period than the other corrections shown. This led me to believe that USDCAD was on the cusp of a rebound.
Combine that with the bullish candle at key support and we had a favorable opportunity to trade a reversal.
What we’re studying here is the relationship between price and time. Said another way, we’re reading the angles of the market to help determine whether buyers or sellers are in control.
So there you have it. The study of impulsive and corrective price action extends beyond the realm of identifying favorable trend continuation signals. The same movements can also be used to discover exhaustion patterns that lead to an extended move in the opposite direction.
I hope you can see the potential of using impulsive and corrective waves in combination with simple price action.
Yes, it takes hard work, dedication and no small amount of time.
But the difference here is that you’re using momentum to stack the odds in your favor (unlike other trading strategies that have you pulling the trigger then hoping things go your way).
Ready to take control of your trading?
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Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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