Trading What I See

The market made an immediate reversal just after today’s opening, and declined for the next 30 minutes to the eventual low. Without any pauses there wasn’t much chance for a safe entry. And without any pullbacks there were no internal measurements to pinpoint the bottom.

So even though we turned at a 78% Fibonacci retracement level, by the end of the first hour I had found no tradable setups. That’s when I drew the magenta bars to mark off the first hour’s high and low, and although we broke out of that range there were still no clear entries.

Finally at the pivot marked with a circled “4″ there was a potential entry. As I said yesterday

where there are two pullbacks in a move, the first one will usually be large (most often 62%) and the second one small (38%.)

Of course the movement over the next hour was just sideways so I gave up on the trade. I should have remembered that we are now into the summer trading season where many of the moves seem to happen in slow motion.

During this season it’s often useful to pay more attention to (but not necessarily trade from) the longer term charts because many of the patterns are extended. Even a move from a three to a five minute chart can clarify moves, since you can include more of the previous day’s trading.

By including part of yesterday’s move on this five minute chart you can see the structure of an Elliott impulse wave. If you realize that Wave Four is often a long drawn-out affair, it might increase your patience in this type of a trade. Remember that I don’t actually trade Elliott Waves as such, but much of what I present on this site is derived from Elliott principles.

There’s another reason to illustrate an Elliott Wave today. Last night I received an e-mail from Elliott Wave International. When they found some of my Elliott comments on Trading What I See during a Google search, they asked me to become one of their associates.

Doing so allows me to put up some links (left sidebar) to free information they offer on their site, such as a very nice 10 lesson Elliott Wave tutorial. For those of you interested in Fibonacci and market structure I highly recommend it.

If you follow any of those links, you’ll have to sign up for Club EWI which puts you on their mailing list. Fortunately they don’t send out material excessively. But it’s a no-cost way to learn more about how the market works (at least some of the time.)

After a well structured five wave move like we had yesterday, a reversal of some sort is common. Not required, but certainly not a surprise. So when the market created a Spring setup at the open, the first red bar could be an entry for a short sale.

The Russell tried again to break above yesterday’s high, but didn’t exceed the first pivot — the most logical place for a stop. From there the market kept getting weaker all day long.

Since Spring setups can catch a lot of breakout players on the wrong side of the market, you will usually get at least an A-B-C move against the previous trend. After the 8:00 pullback price moved right to the parallel trendline just beyond where “C” would equal 100% of “A.” But then price couldn’t get back to the top of the channel.

Of course you couldn’t predict that in advance, but by the time we had reached the blue “X” on the chart, just by drawing trendlines and their parallels after each new pivot gave you a potential short entry at the top of the new channel. How much of the next move you could capture depends entirely upon your money management technique.

Over the past few weeks I’ve been pointing out Fibonacci external retracement measurements based on the first major pullback in a larger move (marked in white.) I look for reversal points at 127% and 162%. However if we get beyond the 162% level the most common turning point is 262%. As you can see, price didn’t even hesitate at that level.

What comes after 262%? In a runaway move there will often be at least a good bounce at 423%, and many times that will end the move. No — that is not a prediction. And no, I’m not carrying a position overnight. But I’ve already marked the 837.50 level on my trading chart for tomorrow — just in case.

The more you can structure your trading the easier it is to make decisions during the day. I use Fibonacci and trendlines as guides, but in yesterday’s comments John asked an Elliott Wave question. Elliott is another way of adding structure, and in many ways it is similar to what I do. Today the market was kind enough to give me a good example. (Elliott Wave traders — forgive me for some simplification.)

In Elliott Wave theory a strong move usually has three pulses in the direction of a trend (circled waves 1, 3, and 5.) An Elliott rule says that the middle wave (3) cannot be the shortest wave. Another says that wave 4 may not drop below the peak of wave 1 (although this rule is sometimes relaxed in commodities and futures.)

A general Elliott guideline also says that waves 2 and 4 will normally be different in some way — either in the depth of correction or in the number of bars in the wave, and often both are true. If you examine today’s chart you will see that all of these rules and guidelines are met.

Unfortunately, as nicely as this chart matches the rules, I have to agree with Robert Miner — in real time you can only find moves that follow clear Elliott Wave patterns about half the time. That’s why what I look for often resembles Elliott, but doesn’t depend upon complete patterns.

Let’s look at the same chart as I describe it in my commentaries. I expect the first pullback to be relatively large (50% or greater) and the second pullback to be smaller (usually 38%.) [Waves 2 and 4 are usually different.]

In a continuing move, the second rally will usually exceed 162% of the first rally. [Larger third wave.] That’s when I start looking for a third rally after the next pullback. A healthy move will also respect the support of previous pivots. [Wave 4 doesn’t enter territory of Wave 1.]

As you can see, there is a lot of similarity between what I do on this blog and Elliott Waves. But when I think in Elliott terms I tend to make predictions, and for me predicting the market often costs me money. So I use Elliott as just another tool — it gives me levels where setups may occur, just like trendlines and general Fibonacci measurements.

For example, at point 4 today we bounced off the pivot support from point 1. Because the second rally had exceeded 162% of the first rally, there was a stronger expectation of more strength ahead. Add in what looks like an Elliott sequence and it just gives more confirmation to the setup.

A basic understanding of Elliott Waves can give you one more profitable way of looking at the market. My favorite EW book is listed below.

Robert Prechter’s Elliott Wave Principle