Dec 11
6
If I hadn’t come down with a case of food poisoning for this year’s International Trader Expo, I would’ve presented ’10 things every Forex trader should be incorporating into their trading’ with my C2FX partner, Leonard Lewis. This seminar covered information about developing your trading plan, methodology and money management. The last thing I planned on presenting was a tutorial on Elliott Wave Theory – but it may not have been what you would expect from an Elliott Wave trader. I was going to discuss disregarding much of Elliott Wave Theory and to instead focus on identifying high-probability Elliott Wave patterns.
Elliott Wave Theory seems to be a love or hate relationship for most traders. For those who use it, they swear by it. On the other hand, there are several who criticize Elliott Wave Theory. Whether you love it or hate it, the major criticism is unless everyone is using the same software to analyze the markets, Elliott Wave is very subjective and heard the joke, if you put 100 Elliott Wave people in a room and show them the same chart, there would be 100 different counts.
So, should you incorporate Elliott Wave Theory into your trading?
The answer is yes. But, unlike many other Elliott Wave traders out there, don’t spend so much time and effort trying to count the waves of the current market.
Elliott Wave consists of 11different patterns, many of which are very similar in structure. However, there are some Elliott Wave patterns unique to the other patterns. Further, these particular patterns possess different rules and guidelines which may, in conjunction with other research, help determine high probability entry points.
I always tell traders the mantra, “scan smarter, not harder.”
A look of bewilderment takes over their face as they try to digest what I’ve just told them. But, simply put, this translates to looking and identifying high probability patterns and forgetting about the current count.
There are 5 patterns we specifically look for when scanning charts, many of which can be easily identified by simply looking at the chart.
The five patterns we look for are: Impulse (IM), Leading Diagonal (LD), Ending Diagonal (ED), Zig Zag (ZZ) and Contracting Triangles (CT).
We also mentioned within these five patterns, there are unique characteristics which can help identify potential high-probability entry points. Let’s examine further.
However, before we go over each pattern individually, we should point out many Elliott Wave practitioners have derived their own set of “rules” and “guidelines”. Rules, as it implies, is something which must be followed and cannot be broken while guidelines are more lenient and mostly deals with percentage retracements (we’ll explain later). Guidelines, in general, are more open to interpretation, research, chart history and other factors so our guidelines may differ from what you use.
IMPULSE (IM)
Impulse is a motive wave and is a strong movement in one direction. Its internal structure is a 5-3-5-3-5 pattern.
Wave 1 must be an impulse or leading diagonal
Wave 2 can be any corrective except a triangle
Wave 2 cannot retrace more than the start of Wave 1
Wave 2 must retrace a minimum of 38.2% of Wave 1 but will most likely retrace to 61.8% of Wave 1
Wave 3 is usually the strongest wave in an Impulse
ZIG ZAG (ZZ)
Wave A must be an impulse or leading diagonal
Wave B must be a corrective pattern
Wave B must be shorter than Wave A by price
Wave B must retrace a minimum of 20% of Wave A by price
LEADING DIAGONAL (LD)
Diagonals move within 2 channel lines drawn from Wave 1 to 3 and from Wave 2 to 4
Wave 1 must be an impulse or leading diagonal
Wave 2 may be any corrective pattern except a triangle
Wave 2 will most likely retrace at least 38.2% of the total price movement of Wave 1
Wave 3 must be an impulse
What do these three patterns have in common? If you’ve noticed, we’ve covered wave 2 projections pretty extensively. This is because Wave 3 of an Impulse, Zig Zag or Leading Diagonal is the most desirous wave to trade because of its characteristics.
In all these patterns, Wave 3 is a 5 wave movement, meaning it is most times a strong movement in the direction of the trend. Further, in an Impulse and Leading Diagonal, Wave 3 cannot be the shortest wave.
Knowing the projections for the end of Wave 2 can help determine potential entry points.
The final two patterns you should scan for is the Ending Diagonal (ED) and Contracting Triangle (CT).
ENDING DIAGONAL (ED)
It is typical for Wave 5 to exceed the channel line.
Once completed, the currency pair will move dramatically in the opposite direction.
CONTRACTING TRIANGLES (CT)
Contracting Triangles can also be referred to as “Continuation” triangles.
Ending Diagonals are fairly simple to spot and once completed, they will move dramatically in the opposite direction, giving you a potential trading opportunity.
Contracting Triangles are the easiest pattern to spot and have a high probability of continuing in the direction of the longer trend when completed. This is why we dub them “Continuation” triangles.
Although these patterns present themselves repeatedly in markets, it is important to note you should never trade off your identification of these patterns. You must do your own analysis, research different time frames and closely analyze the currency pair to consider entering a trade.
In your trading plan, you need to outline your methodology and you must also determine and understand your own personal risk tolerance. Many traders mistakenly think risk tolerance is similar amongst every trader. Every trader has different factors which determine their personal risk tolerance and you must be aware of yours and trade accordingly.
Every trader should think about why they’re trading and what their goals are. I’d imagine most trader’s goals are to make money and become a consistently profitable trader. So, if Elliott Wave or pattern recognition is in your methodology, don’t get so caught up in the current count or cycle of the markets. Instead, look for high probability patterns which will help you become a more consistently profitable trader.
