Elliott Waves Theory – How to Trade Double Extended Impulsive Waves
Elliott defines an impulsive wave as a five waves structure that should have at least one extended wave. The very first impression is a confusing one as only three possibilities for an extended wave are listed: 3rd wave extension, 1st wave extension or 5th wave extension. What is the reason for the “at least one extended wave” mentioning? The answer is quite simple: there are impulsive waves that have two extended waves, and these are being called double extended impulsive waves. As the name suggests, a double extended impulsive wave has two extended waves. The extension applies to the same motive waves: the 3rd, 1st, or the 5th. The only possibility for a double extended impulsive wave to form is to look for the third wave to be extended, and then the 5th wave to extend as well. As a quick reminder, the extension means the wave is bigger than 161.8% when compared with the length of the previous wave. This is the minimum distance to be traveled by an extended wave, but in the case of a double extended wave, the price cannot travel much more than that extension.
Steps to Trade a Double Extended Impulsive Waves
The most common wave to be subject to an extension is the third wave, and this makes a third wave extension impulsive move the most popular one. It is so popular among traders, that almost everyone is looking to trade the 3rd wave to catch the longest wave. In a double extended impulsive wave, the 3rd wave will end up looking like peanuts when compared with the 5th wave, as this last one will be bigger than 161.8% when compared with the length of the 3rd wave! But the 3rd wave was already bigger than 161.8% when compared with the length of the 1st wave! So, you can imagine the strength of the trend that makes up a double extended impulsive wave! To trade such an impulsive wave, one stop loss needs to be hit. However, this is only a normal step, as the loss should be recovered and some profits to be made on top of that. How to do that?
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Trade a 3rd Wave Extension
The way to trade a double extended impulsive move is to treat it as a 3rd wave extension. Remember, at the start of an impulsive wave, we don’t know what kind of an impulsive wave it is going to be. All we know is that the most common setup is for the 3rd wave to extend and it is only normal for this to be the scenario to be traded first. The reason why I said that a stop loss should be hit is the fact that traders will look for the end of the impulsive wave by the time the 3rd wave extension is being reached. Therefore, it is normal for the 5th wave to be faded, meaning traders to look to trade in the opposite direction of the overall impulsive move by the time the 5th wave starts. For this, there’s a stop loss to be placed and this can be 61.8% of the length of the third wave, placed from the end of the 4th wave. In a 3rd wave extension impulsive wave, it is not possible for the 5th wave to move beyond that level! If the stop loss is being hit, it means that the whole move cannot be a 3rd wave extension. A 5th wave extension is out of the question, and this leaves room for only one plausible explanation: a double extended impulsive move is going to form.
Reverse the Trade and Go Aggressively for 161.8%
If, and only if, the stop loss is hit, the thing to do is to reverse the original trade. This can be done either with the same volume or with a bigger volume, as the move that started will be another impulsive wave that will be way bigger than the previous 3rd wave. To be more exact, the 5th wave should be around 161.8% of the 3rd wave, so, to calculate the level, the Fibonacci Expansion tool should be used. It should be dragged from the top until the bottom of the 3rd wave, and then the 161.8% measurement should be taken. This measurement should be then attached to the end of the 4th wave, and this is how the 5th wavelength is deducted. Moreover, this represents the take profit of the previous trade mentioned above, and because the 5th wave is the longest one in the whole five waves structure, the loss will be more than recovered. A double extended impulsive move is common on the foreign exchange market when currency pairs are traveling a lot due to changes in the monetary policy or due to support or resistance levels being broken. However, they are not so common in other markets like the stock market for example. With this double extended impulsive wave, we covered so far all the possibilities for an impulsive wave: a 3rd wave extension, a 1st wave, a 5th wave, and a double extended impulsive move. The next articles here on our Forex Trading Academy will deal with generalities or things to consider in impulsive waves, on each type of extension, except the one treated here. The reason for that is coming from the fact that Elliott found internal Fibonacci relations on different types of extended waves and if they are not respected, the move is not the impulsive wave one was expected it to be. Just to give you an example, in a 1st wave extension impulsive move, the 2nd wave cannot retrace much more than 38.2% of the previous 1st wave. If you do see a retracement more than 38.2%, then most likely the move you thought it is a 1st wave extension, it is not, and the whole count should be revised. This is how Elliott Waves theory works: putting things together to find the right setup.
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Recommended further readings
- “Forex Wave Theory.” Bickford, James L. (2007).
- Neural pattern recognition with self-organizing maps for efficient processing of Forex market data streams. Ciskowski, P., & Zaton, M. (2010, June). In International Conference on Artificial Intelligence and Soft Computing (pp. 307-314). Springer Berlin Heidelberg.