Here is a summary of this series of five waves:
1. Unexpected fundamental pressure—impulsive
2. True believers reassert—corrective
3. Everyone on board—impulsive
4. Exhaustion consolidation—corrective
5. Final overshoot—impulsive
To some readers, the parallels of my trend analysis to the tenets of Elliott wave theory will be obvious; however, I would contend that warrior traders have a deeper knowledge of the process that allows them to maximize the opportunities presented by these swings about the underlying fundamental shift rate. This trending process is also not something that occurs in isolated instances; rather, it can be seen repeatedly, from within the grand scale of many years to within the minutiae of just a few hours. While the pattern does not replicate perfectly, it is there like an evolving musical pattern left only to the skillful trader to play it by ear. The warrior trader, understanding the process and not just the simple technical wave count, can adjust in real time to where the market is at, and therefore remain ahead of the enemy in every stage of the battle.
The two human emotions that dominate in this trend, and any other market trend for that matter, are fear and greed. But it is not simply a case, as many writers and so-called experts suggest, of people being greedy then fearful in rotation. Rather, it is a far more complex interplay among the recent experience of the market, fundamental forces, market positioning, and then fear and greed that dictates the price action. Ultimately, while fundamental forces will always drive the market in the long run and will always win out, the swings and roundabouts are driven by an overlay of other forces. The good news is that the whole process can be understood. It is also worth remembering that the markets are never irrational—they just sometimes appear to be as they try to catch up to what is really happening.
Impulsive versus Corrective Waves
The distinction between impulsive and corrective waves is paramount to the reading of any chart in technical analysis. An impulse wave is identified by its clear directional movement, covering a lot of ground in a relatively short period of time. Any hesitation during an impulse wave is relatively brief, and the market rarely dips back during these periods of hesitation once a new high or low has been made. Corrective periods, by contrast, are easily recognized by their quite whippy and chaotic price action. If there is any period in markets that tends toward the random walk that some theorists have suggested—that is, that markets are completely random in behavior and without rationale—it is during these corrective consolidation phases.
Indeed, while various theories are promulgated to explain what is happening during these corrective periods in price action, I have yet to find one that is able to predict the internal price action of these phases in real time. There are, however, several that, in hindsight, can be applied in a relatively successful manner.
In general, impulse waves are the domain of the trend traders, and corrective periods the domain of range traders. We will discuss this important distinction—which will greatly impact the profitability of your personal trading—in detail a little later. In summary, you should note that markets follow an endless cycle of underestimating the fundamental forces in the direction of the trend and then systematically overpricing those forces. Swinging from one extreme to the other, our actions compounded by the conflicting emotions of fear and greed, we view price action as a constant intertwining path of emotion and reality.
In simple terms, the market gets ahead of the fundamental forces at work, starts to doubt itself, and promptly turns in the opposite direction. The market eventually hits the wall that is the still-trending fundamental force, begins to believe again and reinvests, only to finally fall victim to the changing underlying fundamentals. This is the process that causes significant alternating swings around the central fundamental shift rate.
Read More: The Five-Wave Structure of a Trend
