Impulse Wave Personalities & Characteristics
Each type of Elliott wave pattern has its own “personality” and set of characteristics. Sometimes these personalities can be used to help identify the wave pattern that a stock’s share price may be in the process of developing. Before you start reading the personalities of each wave, take one additional look at the complete 8 wave cycle again. The complete 8 wave cycle illustrated includes a Bullish Impulse Wave Pattern (Waves 1-5) and a Zig-Zag Corrective Wave Pattern (Waves A-C).
Characteristics By Wave
Wave 1
Wave 1 includes the changing of market opinion from bearish to bullish. It is often driven by a rebound from depressed share prices and is usually the shortest of the Impulse Wave structures. Basically, the bargain hunting has begun but the majority of the investors are still pessimistic – they just do not yet believe that the conditions are changing.
Wave 2
Wave 2 is a retracement of Wave 1. Most, if not all, of the gains from Wave 1 are erased because investors have used this rally to sell their losing positions at slightly better prices, not realizing that they should be buying shares instead of selling them. Wave 2 continues the pessimistic outlook for the stock’s share price as investors see little reason to invest in the stock. Value investors are usually the first buyers to step in.
Wave 3
Wave 3 is usually the longest and the strongest of the wave patterns, as most technical indicators at this point have signaled the new uptrend that is taking place. Most investors finally believe in the stock’s rising share price and they rush in to try to follow the “new” trend.
During a Wave 3, it seems as if nothing could go wrong for the stock and the share price is going to keep going up forever. Getting in at the bottom of Wave 3 can generate significant profits.
Wave 4
Wave 4 is the consolidation / correction period of Wave 3’s powerful advance. There are various corrective wave patterns that can develop during a Wave 4 (see the different types of corrective wave pattern illustrations on the “Advanced Elliott Waves” members page).
However, the one rule Wave 4 must abide to is that the low point of this wave may never drop below the peak of Wave 1. Knowing this allows you to jump in on a Wave 4 and ride the last wave upwards (Wave 5) before a longer price correction begins.
Wave 5
Wave 5 is the final stage of the advance and can sometimes be identified by diverging technical indicators. One example of a diverging technical indicator would be a bearish divergence with a stock’s share price and the MACD Histogram. The stock’s share price continues to rise even though the MACD Histogram is starting to show that selling momentum is increasing; this is a bearish divergence.
Late-comers to the stock finally climbed on board during Wave 4’s pullback. These late-comers tried to jump in on a mature trend and buy shares while other investors are selling their shares and locking in gains; the market makers begin short-selling shares when the buying demand dries up.
The first significant increase in the short interest is noted typically at the top of a Wave 5.
Wave A
Wave A is the first wave of the general corrective wave process. At first inclination, Wave A appears to be a normal correction of the previous advance. However, this is actually the first signal that the stock’s trend has changed from bullish to bearish. Being able the identify the beginning of a Wave A as early as possible is critical to being able to lock in maximum profits.
Wave B
Wave B appears to be the resumption of the previous uptrend that was in place, therefore investors that have missed the previous run-ups tend to purchase shares in this area. However, astute Elliott Wave investors know that this corrective wave allows them a last opportunity to exit a long position before the final and most destructive stage of the corrective process begins, Wave C. Price and volume divergence can help to correctly identify a corrective Wave B rather than the resumption of the uptrend.
Wave C
Wave C is the final stage and usually the most destructive part of the corrective wave process. Investors that did not sell during Wave B now feel the relentless selling pressure of Wave C as the share price tends to decrease rapidly. This final corrective wave erases most hope for investors and typically causes panic selling. The outlook for the company is bleak at this point. Investors that can properly identify the completion of a Wave C can get in on the lows for a stock’s share price, offering a very attractive risk to reward ratio. After the completion of Wave C, the cycle repeats itself and typically starts over with the development of a new Wave 1.
Wave Pattern Identification Techniques
Be certain to also check out the “Wave Pattern Identification Techniques” page. I share an Elliott Wave cheat sheet there as well as the methods I use when trying to apply Elliott’s wave theory on a stock chart. I also list the key identifiers I look for when analyzing a stock chart from an Elliott wave perspective.
