What is an Impulse Wave Pattern
Impulse wave pattern is a technical trading term to describe the strong move in a stock's price coinciding with the main direction of the underlying trend. It is used frequently in discussion of the Elliott Wave Theory, a system for predicting stock price movements. Impulse waves also refer to the strong downward movements in a downtrend.
BREAKING DOWN Impulse Wave Pattern
The interesting thing about impulse wave patterns in relation to the Elliott Wave Theory is that they are not limited to a certain time period. This allows some waves to last for several hours, several years or even decades. Regardless of the time frame used, impulse waves always run in the same direction as the primary trend. These impulse waves are shown in the illustration below as wave 1, wave 3 and wave 5.
Elliott Wave Theory was formed by R.N. Elliott in 1935 based on his study of 75 years of stock charts covering various time periods. Elliott, those theory gained wide adoption in the investment community, designed it to provide insights into the probable future direction of larger price movements in the equity market. The theory is designed to be used in conjunction with other technical analysis to pinpoint potential profitable trades.
Elliott Wave Theory seeks to ascertain market or price direction through the study of impulse wave and corrective wave patterns. Impulse waves consist of five shorter waves moving in the same direction as a larger trend while corrective waves are comprised of three shorter waves moving in the opposite direction. To theory advocates, a bull market cycle consists of a five impulse wave advance and a three corrective wave retracement.
Impulse Wave Patterns Today
The magnitude of wave patterns can be measured using Fibonacci numbers, a mathematical sequence of numbers also used in technical analysis. Elliott recommended that adding Fibonacci numbers would improve the precision of wave pattern predictions. Traders use Fibonacci ratios, specifically 38.2%, 50% and 61.8%, that are based on the golden ratio of 1.618, to calculate percentages of drawdowns or uptrends.
Wave patterns are also a part of the Elliott Wave Oscillator, an extension of the original theory that depicts price patterns as positive or negative above or below a fixed horizontal axis.
Elliott Wave Theory continues to be a popular trading tool thanks to the work of Robert Prechter and his colleagues at Elliott Wave International, a market research firm formed to apply and enhance Elliott’s original work by integrating it with such current technologies as artificial intelligence.