How to Trade 2nd and 4th Waves
The Forex market, despite being the most liquid financial market in the world, it is actually spending more time in consolidation rather than trending. Few traders understand this, and, especially swing traders or investors (traders that take a bigger horizon into consideration for the take profit to come) are often losing their patience. As a consequence, the inevitable happens: trades are being closed too early and by the time a trade is closed, the market will almost always start moving. And just like that, an opportunity has been missed just because of lack of patience. According to Elliott, market moves should be classified in impulsive and corrective, and, using this classification for the previous example, it means that an impulsive wave implies the market is trending, while a corrective wave means the market is ranging. Because there are more ranges than trends, it is vital to know how to trade corrective waves and what the implications of such corrections are. In an impulsive wave, or in a five-waves structure, out of the five waves that form the whole impulsive wave, the 2nd, and the 4th ones are corrective.
Steps to be Taken when Trading Corrective Waves in an Impulsive Move
Between the 2nd and the 4th wave, a trader should always favor trading the 2nd wave and not the 4th one. This is due to the fact that the 4th wave is followed by a 5th one that usually is shorter than the 1st wave, and this means that the market will not travel much more beyond the end of the 3rd wave. Having said that, the implications are that the overall impulsive wave will end pretty soon anyways and it is risky to trade the fourth wave. However, this can be done, and conditions for this are listed below in the section dedicated to trading this wave.
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Trading the 2nd Wave – Things to Consider
The 2nd wave in an impulsive move is very tricky to be traded as most of the times traders are seeing it after the fact, namely when the third wave started to move and an extension is obvious. There are cases though when it can be traded and in doing that, profits can be made. Such a wave is not possible the retrace beyond the start of the 1st wave. This is mandatory, so this should represent the absolute invalidation level. It is only normal that the stop loss will be placed at this level. A 2nd wave can end either in the territory of the 1st one or beyond it. In the first instance, the typical retracement level would be between 50% and 61.8%, but not much more than that. If price indeed is retracing beyond the 61.8% level, look for that move to be only the a-wave part of the second wave. In any case, a move into 50%-61.8% retracement into the territory of the 1st wave should be traded. If the 1st wave is bullish, then a long trade can be traded. If it is bearish, a short trade should be open. The stop loss for this trade should be the starting point of the 1st wave. What is to be done if the price is not retracing more than 50% into the territory of the 1st wave? When this is happening, the 2nd wave is most likely forming a running correction. This is even better as such a correction is being followed by an explosion for the 3rd wave, and it is almost certain that the whole impulsive wave will have a third wave extension. In order to trade such a possibility, one needs to wait for the price to come back beyond the end of the 1st wave. This move typically will be a violent one and unprepared traders will think the 3rd wave started. This is totally wrong! The thing to do is to look for a consolidation area to form after that move, typically look for a triangle. By the time the triangle is broken, a new trade can be opened with a stop loss at the end of the 1st wave and targeting 161.8% of the 1st wave, placed at the end of the triangle mentioned earlier.
Trading the 4th Wave – Things to Consider
The 4th wave is offering more possibilities to trade when compared with the 2nd wave, simply because at that moment of time we have enough clues about the overall impulsive wave that is forming. While the 4th wave is not that rewarding, as traders are targeting only the 5th wave to form, it can be traded if the overall move is forming on a bigger time frame, like daily or above. If the 2nd wave was a complex correction, chances are the 4th one is going to be a simple correction. Therefore, look for either a zigzag, flat or a triangle to form. Out of these three patterns, a triangle is less likely, so a flat or a zigzag are the patterns to trade. A fourth wave should not retrace more than 38.2% when compared with the length of the 3rd wave if the 3rd wave is the extended wave. Therefore, one can place a pending order to trade this retracement. More about how to use such a pending order can be found in the article dedicated to trading with pending orders in this section of our Forex Trading Academy project. A typical stop loss for such a trade would be the 50%-61.8% retracement level of the 3rd wave.
If the market is retracing into that area, chances are that the move you traded is actually a corrective wave and not an impulsive one. As for the take profit, the safest place is to set it at the end of the 3rd wave. Such a move is mandatory as market rarely is forming a so-called 5th wave failure. However, it can be placed a bit higher as well or, even better, set an open target with a trailing stop. This way, even if the market is retracing, the stop will be hit, the profit would be booked, and the 4th wave was traded. The a-b-c move most likely started earlier. The 2nd and 4th waves should differ in the time taken for both corrections to form, and sometimes, at least when it comes to the Elliott Waves theory, the time element is even more important than price. If the impulsive wave is forming on a bigger timeframe, make sure you understand price needs time to consolidate and this means it is better to use pending orders. Both 2nd and 4th waves can be really violent, and, as a trader, you’ll be challenged to close the trades. The psychological factor plays an important role in the overall profitability of a trading account as it is unlikely that a trade will move in your favor from the start. It is only normal for a position to show a loss; this is part of the overall trading process. What is not normal is to not understand where you are with the overall count, and to trade randomly. Elliott Waves allows a trader to avoid that, hence profits can be made.
Other educational materials
- Types of Expanding Triangles
- Trading with X Waves
- The Concept of a Running Correction
- Placing Pending Orders When Trading with Elliott
- Overlapping Between Corrective Waves
- The All-Important B Wave Retracement