Technical Analysis

How to trade Elliott Wave

Looking at all of the glossy ads promoting analysis software, educational courses, seminars, workshops, newsletters, past gurus, new gurus, astrologers etc. you could be forgiven for thinking that taking profits out of markets is simply about something called ?forecasting??

All you need to do, apparently, is pay your money and you too can forecast with such amazing accuracy that you?ll be able to trade on the hoof for just an hour a day as you travel from beach resort to, er?beach resort. Yes, it?s really you on the lounger by the pool in that promo!

Strangely enough, trading is not like that. Professional traders have nothing but disdain for the hype and misinformation peddled largely by those catering to the masses of private traders. ?Professional? doesn?t mean ?permanently making money?, by the way. It has a lot more to do with the crucial elements of trading often never even mentioned in the ads and promos. ?Professional? is more an alternative for ?controlling risk?.

Elliott wave can actually help (unbelievably)?

There are two aspects to the practical meaning of risk if you?re actually trading: probability risk (the risk of an unanticipated outcome for a trade) and money risk (the amount of money lost if a trade doesn?t turn out as expected). The first is typically the most difficult of the two to pin down. Everyone accepts that trading with the trend is essential to make money, so in Elliott Wave (EW) terms this could mean aiming to trade off the end of a correction-to-a-trend and back into the trend itself. This can be in one of three places: off the end of a wave 2 into a trend wave 3, off the end of a wave 4 into a trend wave 5 and off the end of a wave B into a trend wave C.

If you can find any of these three places on a chart, you are starting to address probability risk. The ideal would be a correction which unfolds in the simplest possible manner ? as an ABC, zig-zag or 3-wave ? the easiest-to-identify correction in the arcane and complex world of Elliott. The probability of this set-up working is enhanced if it?s completely clear, follows an unambiguous trend and the its wave C is at a critical price level. That price level can be provided consistently by using the well-known Fibonacci ratios comparing one price move with another eg. where there is a cluster of ratios relating wave C to both wave A and wave B.

This is geared to assessing where, say, buying pressure is becoming exhausted in a correction up against a previous established downtrend. Probability risk could be further improved by requiring the market to give a sign that it?s preparing to move in your direction ? before jumping headfirst into a trade. The traditional reversal bars or Japanese candlestick reversal patterns or extreme oscillator reversals can do this job.

It?s easy to get distracted by win/loss stats?

This doesn?t necessarily mean that if you can achieve all this, you?ll have a win/loss ratio up near 100%! Most ?professional? traders with a strong performance record actually work on a win/loss below 50%. They?ve learnt to be comfortable with that, because they understand what novice traders often don?t?

Money risk is the next key. Understanding this risk is to understand not only how much is at risk before a trade is placed but also that your money risk is being kept below a certain proportion of your account. A trader needs to know the entry price and initial protective stop price in advance. Clearly, the closer the entry to the stop the smaller the money risk per share/future/forex lot etc.  The advantage of a structure such as the ABC correction as described above is that the initial stop can always be the extreme price reached in the ABC correction eg. the wave C end. This is where your trade analysis would be proved wrong.

Similarly, the entry price can always be at the extreme of your signal bar, whether a textbook reversal bar, a Japanese doji candlestick or whatever. This is far more difficult to do at other points in any EW sequence, assuming you somehow know where you are in the pattern!

Then it?s a simple matter of dividing that money risk into your maximum money risk per whole trade?say, 2% of a $20,000 account or $400. Your position is now sized.

Risk/reward and profitability?

On the other side of the risk equation for a trader must be the measurement of reward. This has to be clear, easily calculated before every single trade and be constant during a trade. Specializing in trading off potential ABC corrections gives you an advantage here?the EW price levels that would be reached if the trade works as anticipated are the natural reward levels to take. For instance, if you trade off an ABC correction at a potential wave 2 low, the minimum, typical and maximum wave 3 price levels are there to be used in your reward assessment. Again, these levels are all based on Fibonacci numbers, so your reward levels can be clearly defined for each trade. You can know your risk/reward potential before committing any capital at all.

Now it is simply a numbers game and one that novices often lose by excessive emphasis on the win/loss statistic. Winning 70% of your trades is no use if you only win $400 on each winner but lose $1000 on each loser. In practice, most profitable professionals have a win/loss ratio below 50% (sometimes well below?) but control of risk and concentration on risk versus reward enables them to limit the losses against the wins. Result ? profits.

Elliott wave has to be stripped, though?

As Elliott theory all too often seems the preserve of academics, a stark approach is needed. The standard pitfalls of EW have to be avoided, otherwise you have little chance of success. An ?isolation approach? sidesteps the need to fit a current pattern into a previous pattern or into a larger timeframe (or several ? there are 9 different Elliott frames cited by Frost & Prechter in their seminal ?Elliott Wave Principle?). There?s no need to desperately squeeze a smaller pattern out of your current pattern on-screen or to struggle with dreaded ?alternate counts?.

This also means no interference mid-trade, avoiding the dangers of EW counts changing when you?re in an open position ? such uncertainty is completely unwelcome!

All in all, controlling risk rather than obsessing about accuracy, you have a chance of at least buying a sun lounger like the one in the ad!

Tony Beckwith gained a B.A. (Hons) degree in Economics from Gonville & Caius College, Cambridge University, U.K., in 1983. From 1983 to 1985, he worked in the City of London as a global economist (focusing on Japan and the U.K.) for the Japanese broker Yamaichi International (Europe) Ltd. This included training at Yamaichi Securities head office in Tokyo.From 1986 to 1988, he worked in London as a Japanese markets economist and equities/warrants broker to institutional clients at the U.K. broker County Securities (owned by NatWest Bank).In 1988, he joined James Capel & Co. (now part of HSBC Group) as a Japanese equity and warrants broker, increasingly using technical analysis and quant work with his client base. As a Senior Executive, he was appointed department Head of U.K. Sales in 1993. From 1995 to 1998, he worked for Salomon Brothers International Ltd. (Europe) on the Japanese equities desk, again in the London office. In 1998, he started trading and researching privately and continues to do so. He is an Associate Member of The Society of Technical Analysts in the U.K.Tony has written articles for Stocks & Commodities™, Traders World, The Technical Analyst and the Exchange. He is the Director of Sales & Marketing for the MTPredictor™ product range.

Tony Beckwith gained a B.A. (Hons) degree in Economics from Gonville & Caius College, Cambridge University, U.K., in 1983. From 1983 to 1985, he w...

Bluebelle

Member
70 2
Having read this article, I still can't see how EW theory can be applied other than retrospectively, and even then it often seems dubious. Having read a bit about it a while ago, I saw BIll Adlard's presentation at the MI seminar when he prefaced many of his slides with the words 'as you can clearly see' or similar. In subsequent discussion it emerged that I wasn't the only one that couldn't.

I simply don't see how it can be relied on as a predictive tool anymore than any form of conventional TA can. It reminds me of those aerial photos which the intelligence community say clearly show nuclear silos or whatever, when they seem to everyone else as if they could equally well show that the cameraman has photographed his own left boot.

Anyone, well most people, can be wise after the event. Post event wisdom seems to me to be the best EW theory offers.

Discuss !!!
 

stk1975

Newbie
1 0
My problem with EW is that if you ask two people to interpret the waves, they will definitely not agree on the form. Not only that, each individual will have doubts about his/her analysis.

Is there any easier way to do this? I have not giving up on theory yet, becuase the fundamental concept make more sense than any systems up there.
 

Bigbusiness

Experienced member
1,408 23
stk1975 said:
My problem with EW is that if you ask two people to interpret the waves, they will definitely not agree on the form. Not only that, each individual will have doubts about his/her analysis.

Is there any easier way to do this? I have not giving up on theory yet, because the fundamental concept make more sense than any systems up there.
Some people try to combine EW with Fibonacci/Gann time and price projections or Delta to improve the accuracy. I looked in to this but still found it highly subjective. There are better methods but people won't share something that works well. The best way is to work out your own methods.
 

SOCRATES

Veteren member
4,966 134
Bigbusiness said:
Some people try to combine EW with Fibonacci/Gann time and price projections or Delta to improve the accuracy. I looked in to this but still found it highly subjective. There are better methods but people won't share something that works well. The best way is to work out your own methods.
:LOL: Yes precisely.
 

lazydave

Newbie
6 0
EW Trading Breakdown

Trading using Elliott Waves boils down to:

Is the current market action impulsive or corrective? Usually easy to decide, do the waves overlap or not?

If it's corrective, what type of correction is it, zig-zag, flat, triangle, double or triple three etc, and based on that where will it likely end? Here it's useful to know that corrective waves are almost always at a shallower angle than the impulse wave they are correcting. So a 3 wave move opposite a prior impulse that is steeper than the impulse is probably only wave A (or W) of the correction. Fibonacci levels are also useful - a 62% or 78% retracement of an impulse is a good place to bet in the direction of the impulse with limited risk if you place a stop beyond the 100% retracement level. Also zig-zags often have a steep wave A and a shallower wave C, while flats are the opposite. Triangles are tricky because there's usually at least one complex wave, and what you think is wave C or D of an ABCDE is actually only wave A or B of C. Other more complex corrective waves are probably best avoided since it's easy to see a pattern that isn't there.

When a correction looks complete, the next move is an impulse in the opposite direction so it should work quickly in your favor if your analysis is correct. If it starts going your way a little but then quickly slows down this a good clue that things are not as they seem and you can bail out even before things get bad enough to hit your stop. If the correction keeps grinding on, stopping you out perhaps repeatedly, probably you are using too close a stop, and you should reduce your position size to allow a wider stop.

Of course this is all easy to say and hard to do :)
 

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