This is a guest post by Andrew Bezen.
Elliott Waves theory is considered to be one of the trading theories that perfectly illustrates human behavior. The market is moving based on imbalances between supply and demand levels. Unfortunately, these levels cannot be seen when trading the Forex market. There is a reason for that: the Forex market is the biggest one in the world and it is not possible to have access to all the volume in the world.
The volume indicators that can be found on any trading platform refer only to the volume of that specific broker, not the volume of the whole market. This makes it difficult to interpret trends based on the volume indicators and leaves the Elliott Waves as the only theory that allows incorporating human nature in the market interpretation.
According to Elliott, the market moves in impulsive and corrective waves. Impulsive waves are five-wave structures and corrective waves are three-waves structure. An impulsive wave is always labeled with numbers: 1-2-3-4-5.
There are many rules to look for being respected in an impulsive move. For example, it is not possible for price action that follows after the 1st wave to retrace beyond the start of the 1st wave. In plain English, the 2nd wave cannot retrace beyond the start of the impulsive move.
This is a powerful statement that gives traders the opportunity to buy a retracement in a second wave when this is coming in a bullish impulsive move. Moreover, it is said that at least one wave needs to be extended, to be the longest, to stand out of the crowd. That wave is usually the 3rd wave.
What traders do is they take the Fibonacci extension tool (or the retracement one and add the 161.8% level), find the 161.8% level and apply that outcome at the end of the 2nd wave. Attention here: the result is calculated based on the length of the first wave. Therefore, traders have the entry (a pullback in the territory of the 1st wave), the stop loss (at the start of the impulsive move, or the start of the 1st wave) and a take profit (measure the 161.8% distance when compared with the length of the 1st wave and project it from the end of the 2nd wave).
It is no wonder all traders using the Elliott Waves theory try to hunt the third wave, as it is most of the times the longest wave in the five-wave structure. But this is not the case all the time. Sometimes, the 1st wave is the longest one in the structure and Elliott called this possibility a 1st wave extension impulsive move. In the Forex market, they are quite common.
When the 5th wave is the longest, it is said that the market forms a fifth wave extension impulsive move. It should be mentioned here that this is a rare possibility the market makes and if you think you found such a wave, it is only part of a corrective structure of a bigger degree. Speaking of corrective structures, impulsive waves form mostly in corrective structures, rather than in impulsive waves of a bigger degree. Therefore, they appear either as the c-wave of a flat, or the a and c-waves of a zigzag and rarely as a classical impulsive move.
Why is that? Because of the market, spends most of the time in consolidation and even breakouts are considered to be part of a corrective wave, rather than an impulsive one. The Elliott theory was developed based on how the stock market is moving but can be easily adapted to other markets, the Forex market being included here.
The only difference is that the Forex market is open 24/5 and the volatility is a big higher. But the rules of the Elliott theory should be the same in the Forex market too. Any forex broker that offers educational programs to its traders should include the Elliott Waves theory as part of their programs.