Trading What I See

Elliott Waves are something you won’t hear me talk about too much on this blog, not because I don’t see them (and occasionally trade them), but because my main techniques just use Fibonacci relationships which I consider more understandable.

I remember a statement by Bob Prechter many years ago - after studying Elliott you won’t be able to “not” see the wave patterns. My problem is that in real time I still see wave patterns that turn into something else. My Fib lines don’t change.

But the Elliott numbering on today’s chart makes explaining a beautiful Fibonacci cluster much easier. And in truth, much of the Fibonacci work I discuss every day is directly related to Elliott wave structure.

For those not familiar with Elliott — the waves are numbered or lettered at their ends so that we can talk about them easily. That’s as deep as we need to go. Today’s market opened between numbers 1 and 2 with a pullback to two declining moving averages. It was a nice 62% pullback — typical of the first correction in a longer move. Two reasons for a short sale.

And no reason to get out before the bottom. Notice that there was no “Dunnigan” green bar until the bounce, which occurred right at Wednesday’s low. And then we moved up in a typical ABC correction. Point “C” is what I want to talk about today. There were four Fibonacci relationships that occurred at exactly the same level — it’s called a Fib cluster, and the relationships are directly related to Elliott waves.

The first retracement is of wave 3. Point “C” is a 50% pullback of this move. A Fib pullback is nice, but it is even more reliable when it matches some other Fibonacci relationship, and in this case the most obvious one is a measurement from point “0″ (the origin of the entire move) to point “3″. That pullback was 38%.

A measurement that many miss is called a Fibonacci extension. (It is also called an Alternate Price Projection.) This is when you compare a move with the previous move in the same direction. Measuring wave 2 (from 1 to 2) can sometimes give you a hint as to how long wave 4 will be. The most typical length is either equal to wave 2 or 162% of wave 2. Today the second possibility pointed to the same level as our other two measurements. We now have three reasons to think the market may turn at this point.

Whenever possible, you should look at smaller movements to confirm a larger Fibonacci ratio. Notice that the distance from point “3″ to “4″ is marked with an A-B-C. The distance from “B” to “C” is 162% of the distance from “A” to “B”. That gives us four Fibonacci projections being met at exactly the same level. Although it could happen, I would be very disappointed if the market didn’t turn there.

Notice that almost everything I have mentioned so far has been Fibonacci, not Elliott. Much of the time that is all that is needed, and Elliott waves are really a description of what has happened in the past. But after wave 4 you can use some Elliott knowledge to make a guess at the future.

If that was a valid wave 3 (and it looks like one), then it should be followed by another move down — probably subdivided into three pulses, with the middle one the strongest. That’s why I marked point “5″ on the second bottom rather than the first. And a logical stopping place is 127% of the length of wave 4.

Target 127%. Three pulses down, as expected. Double bottom. Divergence in the Stochastic. Not only do we go up from there, but according to Elliott theory we’ll probably re-visit the area of the top of wave 4. And that’s what happened.

Elliott, when it works, can be amazingly precise. But when it doesn’t, it can keep you out of some good trades and get you into some bad ones. I learned years ago that Elliott shouldn’t be my main trading technique. But I love to watch the patterns play out.

By coincidence, as I was writing this post I got an e-mail from Elliott Wave International (Bob Prechter’s organization) advertising one of their “Free Weeks” starting next Tuesday. It will probably only cover commodities, but if you are interested, check out www.elliottwave.com/wave/freeweek. You’ll have to join their mailing list, but it’s usually interesting.

And although I’ve avoided mentioning Elliott on this blog until today, I’m curious how many would like me to point out some of the patterns I occasionally see. If so, let me know by leaving a comment below.

Robert Prechter’s Elliott Wave Principle