Lesson 1:
Ready, Aim ... Fire: Knowing When To Place a Trade
A very important question you need to answer if you are going to use the Wave Principle to identify high-probability trade setups is, "When does a wave count become a trade?"
To answer this question, let me draw upon the steps required to fire a firearm:
Step 1 (Ready) -- Hold the rifle or pistol still...very still.
Step 2 (Aim) -- Focus and align your sights.
Step 3 (Fire) -- Pull the trigger without tensing your hand.
If you follow these steps, you should at least hit what you're aiming at, and, with a little practice, you should hit the target's bull's-eye more often than not.
As an Elliottician and a trader, I employ a similar three-step approach to decide when to place a trade. Figure 1 shows a schematic diagram of a five-wave advance followed by a three-wave decline -- let's call it a Zigzag. The picture these waves illustrate is what I call the Ready stage.
In Figure 2, prices are moving upward as indicated by the arrow. At this stage, I begin to Aim as I watch price action to see if it will confirm my wave count by moving in the direction determined by my labeling.
Once prices do indeed begin to confirm my wave count, I then determine the price level at which I will pull the trigger and Fire (that is, initiate a trade). And, as you can see in Figure 3, that level is the extreme of wave B.
Why do I wait for the extreme of wave B of a Zigzag to give way before initiating a position? Simple. By waiting, I allow the market time to either prove or disprove my wave count. Moreover, once the extreme of wave B is exceeded, it leaves behind a three-wave decline from the previous extreme. As you know, three-wave moves are corrections according to the Wave Principle, and as such, are destined to be more than fully retraced once complete. An additional bonus of this approach is that it allows me to easily and confidently determine an initial protective stop, the extreme of wave C.
Remember, all markets have a wave count; however, all wave counts don't offer a trading opportunity. So the next time you think you have a wave count, rather than just blindly jumping in, first steady yourself, wait while you aim, and then -- if price action does indeed confirm your wave count -- pull the trigger. Also, it is important to note that this is my way of applying the Wave Principle practically, but it's by no means the only way.
Learn how to apply Elliott wave analysis on your charts in Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week that teach you how to spot and act on trading opportunities in any market.
Lesson 2:
Spotting a Head & Shoulders Pattern in the Euro
My primary tool as a technical analyst is, of course, the Wave Principle. Even so, I find great value in other forms of technical analysis, such as candlesticks and indicators.
With this in mind, let's review one of my favorite old-school chart patterns -- Head-and-Shoulders. This formation was popularized by Edwards and Magee in their seminal work Technical Analysis of Stock Trends. It is a reversal pattern and consists of a left shoulder, a head and a right shoulder. A trendline drawn between the price extremes of the left shoulder and head and head and right shoulder is referred to as the neckline.
The neckline is important for two reasons -- the first being that a parallel of the neckline drawn against the extreme of the left shoulder can identify the extent of the formation of the right shoulder. The second important aspect of the neckline is that it can provide a high probability target for the subsequent breakout. If prices decisively penetrate the neckline, the distance between that point and the head is often a reliable objective for the ensuing price move.
This video is from Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week to teach how you can spot and act on opportunities in any market.
Lesson 3:
How To Identify Turning Points Using Fibonacci Retracements
The primary Fibonacci ratios that I use in identifying wave retracements are .236, .382, .500, .618 and .786. Some of you might say that .500 and .786 are not Fibonacci ratios; well, it's all in the math. If you divide the second month of Leonardo's rabbit example by the third month, the answer is .500, 1 divided by 2; .786 is simply the square root of .618.
There are many different Fibonacci ratios used to determine retracement levels. The most common are .382 and .618. However, .472, .764 and .707 are also popular choices. The decision to use a certain level is a personal choice. What you continue to use will be determined by the markets.
The accompanying charts demonstrate the relevance of .236, .382, .500 .618 and .786. It's worth noting that Fibonacci retracements can be used on any time frame to identify potential reversal points. An important aspect to remember is that a Fibonacci retracement of a previous wave on a weekly chart is more significant than what you would find on a 60-minute chart.
With five chances, there are not many things I couldn't accomplish. Likewise, with five retracement levels, there won't be many pullbacks that I'll miss. So how do you use Fibonacci retracements in the real world, when you're trading? Do you buy or sell a .382 retracement or wait for a test of the .618 level, only to realize that prices reversed at the .500 level?
The Elliott Wave Principle provides us with a framework that allows us to focus on certain levels at certain times. For example, the most common retracements for waves two, B and X are .500 or .618 of the previous wave. Wave four typically ends at or near a .382 retracement of the prior third wave that it is correcting.
In addition to the above guidelines, I have come up with a few of my own over the past 10 years. The first is that the best third waves originate from deep second waves. In the wave two position, I like to see a test of the .618 retracement of wave one or even .786. Chances are that a shallower wave two is actually a B or an X wave. In the fourth-wave position, I find the most common Fibonacci retracements to be .382 or .500. On occasion, you will see wave four retrace .618 of wave three. However, when this occurs, it is often sharp and quickly reversed. My rule of thumb for fourth waves is that whatever is done in price, won't be done in time. What I mean by this is that if wave four is time-consuming, the relevant Fibonacci retracement is usually shallow, .236 or .382. For example, in a contracting triangle where prices seem to chop around forever, wave e of the pattern will end at or near a .236 or .382 retracement of wave three. When wave four is proportional in time to the first three waves, I find the .500 retracement significant. A fourth wave that consumes less time than wave two will often test the .618 retracement of wave three and suggests that more players are entering the market, as evidenced by the price volatility. And finally, in a fast market, like a "third of a third wave," you'll find that retracements are shallow, .236 or .382.
In closing, there are two things I would like to mention. First, in each of the accompanying examples, you'll notice that retracement levels repeat. Within the decline from the February high in July Sugar (Figure 28), each countertrend move was a .618 retracement of the previous wave. Figure 29 demonstrates the same tendency with the .786 retracement. This event is common and is caused by the fractal nature of the markets.
Second, Fibonacci retracements identify high probability targets for the termination of a wave; they do not represent an absolute must-hold level. So when using Fibonacci retracements, don't be surprised to see prices reverse a few ticks above or below a Fibonacci target. This occurs because other traders are viewing the same levels and trade accordingly. Fibonacci retracements help to focus your attention on a specific price level at a specific time; how prices react at that point determines the significance of the level.
Learn how to use Fibonacci retracements and targets on your charts in Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week that teach you how to spot and act on trading opportunities in any market.
Lesson 4:
How to Use Candlesticks to Identify a High-Probability Trade Setup in Chipotle
If you think you need years of experience to identify a high probability trade setup -- you're wrong. To prove my point, let's examine three price charts using only a few popular Japanese Candlestick patterns and a single simple moving average (SMA).
Japanese Candlestick analysis has been around for hundreds of years and was introduced to the West by Steve Nison. The information contained in a candlestick chart is the same that is contained in an open-high-low-close chart, except that the data is presented differently using "shadows" and "real bodies." Moreover, these candlesticks form patterns which are important to traders. If you would like to learn more about candlesticks, I highly recommend the book Japanese Candlestick Charting Techniques by Steve Nison.
How do two tools -- candlesticks and a 20-period SMA -- identify high probability trade setups? The answer is simple in that you use the 20-period SMA to identify the trend and then focus your attention on the appropriate candlestick patterns. If the trend is up, as defined by the slope of the 20-period SMA, focus your attention on bullish engulfing patterns, piercing lines and morning stars. If the trend is down, as defined by the slope of the 20-period SMA, focus your attention on bearish engulfing patterns, dark cloud cover patterns and evening stars.
This video is from Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week to teach how you can spot and act on opportunities in any market.
Lesson 5:
Union Pacific: How to Trade an Ending Diagonal
Today, we are going to examine the second kind of motive wave -- an ending diagonal -- in Union Pacific (UNP).
Now, there are two types of wave forms -- motive waves and corrective waves. Within these two categories, motive waves include impulse waves and ending diagonals. Zigzags, flats and triangles are all corrective wave patterns.
An ending diagonal is an easily discernable wave pattern because it looks like a rising or falling wedge. Specifically, it is a five-wave overlapping pattern wherein each wave subdivides into three smaller waves. Also, trendlines connecting the extremes of waves one and three, and two and four often converge.
Two qualities of an ending diagonal that are important to remember are where they can form and how they resolve. Ending diagonals can form only in the fifth wave position of an impulse wave or the wave C position of an A-B-C formation.
Price behavior following an ending diagonal is also quite impressive because it tends to be swift, retracing the entire length of the pattern. The guideline covering the resolution of an ending diagonal is that it will be more than fully retraced in one-third to one-half the time it takes the pattern to form, just as in Union Pacific.
This video is from Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week to teach how you can spot and act on opportunities in any market.
Lesson 6:
How a Key Reversal Bar Pattern Can Lead You to a Trade Setup
Ready, Set ... Wait
A trade setup that I'm always on the lookout for is a double close key reversal outside bar combination. A double close key reversal forms when prices make a new extreme, yet close above or below the prior two closes. The outside bar portion of this formation is self explanatory in that the current bar's high and low are above and below the previous price bar's high and low.
It is important to remember that this bar pattern is a setup only and not a signal to immediately take a trade -- long or short. For this formation to become tradable, it must prove itself by trading beyond the key reversal bar's high or low. If the high of the key reversal bar is penetrated, then the low of the key reversal bar may act as an initial protective stop and vice versa for shorts.
Too often, individuals take a ready-fire-aim approach to trading -- a trade setup is different from a trade trigger. By employing these guidelines, your trading style becomes one of ready-aim-aim-aim-fire.
This video is from Elliott Wave Junctures, EWI's new service that provides 3-5 video lessons each week to teach how you can spot and act on opportunities in any market.