Trending markets often move in what is known as a 5-3 wave pattern. The 5 waves are known as impulse waves, and the 3 waves are known as corrective waves.
Wave 1, 3, and 5 are the waves that you will anticipate are going to move along with the overall trend in that market.
Meanwhile, waves 2 and 4 are corrective and may move in the opposite direction from the market. Take a look at this chart to see how the different waves may look on a given chart:
The currency makes it move upward. This first wave is generated by a small number of traders who are true believers that the value of the pair ought to be higher than it is currently trading.
There are enough people who owned the pair before the first wave who want to jump ship and take some profits. Their profit-taking leads to the second wave and a small push downward.
This wave tends to be the strongest in the entire move. The public as a whole has seen the value to be had in the pair, and they all jump in at nearly the same time as the second wave is losing steam. This pushes the pair even higher than it was when the first wave let up.
Traders once again take some profits off the table as they are simply excited and happy to have caught the big move in Wave 3. They are going to peel away some of the risk that they have taken so that they can live to trade again.
This is the part of the wave that is driven by FOMO or mass hysteria. Basically, everyone who didn’t catch the moves before is now looking for a way to get in on a movement that may not even have that much steam left in the tank at this point. It can be very dangerous to try to get involved with a pair at this point, but that doesn’t stop some people from giving it a try anyway.
Extended Impulse Waves
It is important to remember one of waves 1, 3, and 5 should be extended. This is to say that one of these three waves will be longer than the others as more traders get involved. It tends to be wave 3, but that is not always the case.
Sometimes, the most extended and prolonged move is at the very end when people pile on as they try to catch the last remaining bit of a big move. Whatever the case, it is important to remember that one wave will be lengthier than the others.