Elliott Waves Theory – Defining Corrective Waves
This part of the overall Elliott Waves theory is the one that is most of the times totally misunderstood. Corrective waves are so important though in the overall interpretation of the moves the market makes that are vital to any correct Elliott labeling.
Before starting a discussion about corrective waves and what are the main things to consider, Forex traders should know that they are way more common than impulsive waves. This means corrective waves are forming more often and therefore, labeling should be made mostly with letters.
The previous article here on our Forex Trading Academy discussed what makes an impulsive wave and if that seemed confusing, then corrective waves will give you an even harder time. Elliott discovered many corrective waves, and they are ranging from the place they appear, their interpretation, construction, etc. There are so many things to consider that the best approach is to start with the very basic things and then slowly but surely building on the whole theory.
According to Elliott, a five-waves structure (1-2-3-4-5) is followed by a third wave correction (a-b-c). This sequence represents a cycle and all the waves in this cycle are of the same degree.
Such a cycle can be the 1st and the 2nd wave of an impulsive wave, or the 3rd and the 4th wave, as explained in the previous article where impulsive waves were defined. Out of the whole 1-2-3-4-5 and a-b-c sequence that defines a cycle, the 2nd, and the 4th waves, together with waves, a and b are corrective in nature.
This is a very powerful statement as, from this moment on, any discussion involving impulsive waves is referring only to the 1st, 3rd, 5th, and c-waves, while corrective waves are the 2nd, 4th, a-waves and b-waves. Already the overall analytical process of Elliott Waves thinking is better structured when compared to the beginning of this part of our overall project.
Corrective Waves Generalities
Moving forward with this article, the focus will be on the 2nd and 4th, as well as on the a-wave and b-wave, as they are the corrective waves in an Elliott cycle. Despite the fact that they are part of the same category, they are very different and their interpretation is subject to different things to be considered.
To divide things even further, it is time to mention that Elliott found two types of corrective waves to form: simple and complex corrections. Both of them are important and by the time a trader decides a move is a corrective one, the next thing to do is to establish if the correction is a simple or a complex one.
2nd Wave Characteristics
Any 2nd wave in a five-waves structure is a corrective wave, and it can be either a simple or a complex correction. Most of the times, this wave is a complex correction that retraces deeply into the territory of the 1st wave.
The general belief is that the 2nd wave should retrace between 50% and 61.8% of the first wave, and traders will trade aggressively on such retracement as the third wave in an impulsive wave (the one that it is usually the extended wave) is about to start. Such a belief is not correct as, if price really retraces to the 61.8% level it is only part of the 2nd wave and not the end of it.
It is mandatory for the 2nd wave to retrace into the territory of the 1st wave, but not mandatory to end into that territory. If it ends higher or lower, depending on the type of the impulsive wave, it is being said that the 2nd wave is a running correction.
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4th Wave Characteristics
The 4th wave in any five-wave structure must be corrective in nature and can be a simple or a complex correction. It is not possible for the 4th wave to completely retrace the 3rd wave, nor for it to enter the territory of the 2nd wave.
A typical retracement for the fourth wave would be anywhere between 38.2% and 50% retracement into the territory of the 3rd wave. As a matter of fact, if the price is retracing more than 50% into the territory of the 3rd wave, this retracement should be viewed as only part of the 4th wave, and not the end of it.
“Wave a” Characteristics
If we’re discussing an a-wave, then this implies a five-waves structure is already completed. The a-wave is part of the overall move that corrects the initial five-waves structure and therefore its interpretation is crucial.
At this very moment, the Elliott Waves theory divides even further. As mentioned above, the a-wave is listed in the corrective waves category. Which is very much true, with one exception: if it is the first part of a zigzag (a zigzag is a simple corrective wave that will be covered later in our project).
Having said that, after an impulsive wave to the upside, for example, or a bullish five-waves sequence, the a-wave is the first bearish reaction to that impulsive wave. It can be an impulsive wave of a lower degree, hence respecting the rules of an impulsive wave or a corrective wave of a lower degree.
If it turns out it is a corrective wave, then it can be a simple or a complex correction as well. As a rule of thumb, if the a-wave that follows an impulsive wave is an impulsive wave, it will be retraced less than 61.8%. On the other hand, if it is a corrective wave, then the move to follow is mandatory to retrace beyond the all-important 61.8% level.
“Wave b” Characteristics
The b-wave in any type of Elliott Waves structure is mandatory to be a corrective wave. As it was the case with the previous corrective waves mentioned here, it can be a simple or a complex correction on its own.
This is one of the most difficult waves to be found and interpret, but the whole count depends on it. Such a wave can retrace completely the previous a-wave and can give the impression that the overall correction ended.
All in all, corrective waves are more common than impulsive structures and the characteristics listed in this article are only meant to define their structure. Bear in mind though that these are only generalities, as complex corrections can form on each and every corrective wave from the ones listed above.
Other educational materials
- What is Elliott Waves Theory?
- Defining Impulsive Waves
- Use the Fibonacci Extension Tool in Elliott Waves Theory
- Different Fibonacci Levels Important When Trading with Elliott
- Trading Different Types of Extended Waves
- Bill Williams – How to Use Williams Indicators When Trading Forex
Recommended further readings
- Theories and reasons for wave patterns in economic development and their implications, BM Ndlovu – The International Financial Crisis
- Methodology for Elliott waves pattern recognition, M Kotyrba, E Volna, M Janosek, H Habiballa, D Brazina – ratio, 2013 – scs-europe.net