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Except for unusual circumstances, price moves in waves and not in a straight-line run. These waves are like the tide coming in.
Price advances and recedes, advances a bit more and recedes, slowly creeping up the shore. The outgoing tide shows the wave
advance not as far as previous waves, and withdrawing further.
The above figure is a picture of the wave moving up the shoreline as high tide approaches. The water rises in a series of
advancing waves followed by receding ones. The motive phase takes the shape of a five wave structure (1 through 5) followed by the corrective
phase which has three waves (ABC).
The motive phase is composed of three advancing waves, 1, 3, and 5 and counter trend waves 2 and 4. Following the motive
wave comes the corrective phase. It shows two receding waves, A and C, with a counter trend wave between, B. The series, 1 through
5 and A through C can be repeated to show how the tide comes in, or price advances up the chart.
If you were to zoom in on waves 1 and 2, you would see the same 1 through 5 and ABC combination. You can say the same about
waves 3 and 4, 5 and A, B and C (with the structure reversed). In this manner, the cycle is fractal, meaning the closer you
zoom in, the more motive and corrective phase combinations you see. If you were to zoom out, say look at the structure from across
the room or from the other side of your yard, the 1 through 5 and ABC combination would take the shape of waves 1 and 2.
Motive waves do not always point up and corrective waves do not always point down. If you were to use a microscope to look
at waves A-B from the above chart (not the chart to the right), you would see a five wave structure heading lower (waves 1 through 5) followed by a three wave, ABC, correction.
I show this in the chart to the right. Frost and Prechter describe this movement best when they write,
"...the essential underlying tendency of the Wave principle is that action in the same direction as the one larger trend develops in five waves, while reaction
against the one larger trend develops in three waves, at all degrees of trend." That is an important statement. It is not entirely
accurate, but I like to think of it this way: five waves align with the primary trend and the corrective phase is the counter trend
move. The primary trend can be up (bullish) or down (bearish).
Trends that align with the primary trend (wave of higher degree) form in 5 waves. Counter trends develop in 3 waves. So if you expect
price to continue rising, look for 5 waves.
Rules
The complete eight wave cycle has rules that govern its shape. They are listed here.
- The motive phase is composed of five waves, three advancing (1, 3, 5) and two counter trend waves, 2 and 4.
- The corrective phase is composed of three waves, two receding (A and C) and one counter trend wave, B.
- Motive waves can head up or down.
- Corrective waves can head up or down.
- The motive phase aligns with the larger trend.
- The corrective phase is a counter trend move against the larger trend.
- Wave 2 never moves beyond the start of wave 1.
- Wave 3 is never the shortest wave.
- Wave 4 never overlaps wave 1.
- This is an observation: one of the waves, 1, 3, or 5, will often (but not always) be much longer (extended) than the other two.
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