The point in using the rules and guidelines of the Elliott Wave Theory is to know where in the overall structure is the market right now, and what portion of that motion are they most likely to. The euro traded largely sideways during the day. It first moved upwards for 60 pips, retracing % of the previous decline, then swinging up and down within an increasingly converging range.
It is this development that continues to drive interest in the forex markets. This article will examine a method to trade forex markets using the Elliott Wave Theory. The Elliott Wave Theory The Elliott Wave Theory is a method of analysis developed by Ralph Nelson Elliott that is based on the theory that, in nature, many things happen in a five-wave pattern.
As applied to the financial markets , the assumption is that a given market will advance in a pattern of five waves — three up waves, numbered 1, 3 and 5 - which are separated by two down waves, number 2 and number 4. The theory further holds that each five-wave up-move will be followed by a down-move also consisting of five waves — this time, three down waves, numbered 1, 3 and 5, separated by two up waves numbered two and four.
In addition, the theory holds that each of the countertrend waves — i. In other words, during waves 2 and 4 of a five-wave uptrend , the security in question will retrace part of the wave 1 advance in a pattern consisting of two smaller down waves labeled A and C separated by one up wave labeled B.
Likewise, during waves 2 and 4 of a five-wave down-trend, the security in question will retrace part of the wave one decline in a pattern consisting of two smaller up-waves labeled A and C separated by one down-wave labeled B. In reality, things typically do not unfold in such a neat, clean, and easy to follow five-wave pattern. As a result, many individuals who espouse a belief in Elliott Wave analysis nevertheless end up interpreting the current wave count differently than other adherents.
And in fact, it can be argued that the Elliott Wave is as much an art as it is a science, and that various interpretations are to be expected.
As such, one important thing to note is that this article is not so much about how to generate an Elliott Wave count — since so many individuals end up with different interpretations — but rather about how to trade forex markets using the Elliott Wave as the driving force.
For the purposes of this article, I will use the Elliott Wave count as generated objectively by ProfitSource source software by Hubb. The software has an automated algorithm for generating and displaying the wave count. It should be noted that the preferred count can change dramatically from one day to the next based on the built-in algorithm, and that another person or program may arrive at a different interpretation of the wave count and any given point in time.
Still the benefit of using this method is that for better or worse, the count is calculated using an objective algorithm and is not open to subjective interpretation. Laying Out the Steps of a Plan Before embarking on any trading campaign it is essential to have a plan in place. So let's set up a straightforward plan for using Elliott Wave as a basis for trading forex markets.
Here are the steps that we will employ:. These two confirming actions do not have to take place on the day that the wave number changes from 3 to 4. As long as the both occur at some point prior to the wave count being something other than 4, then a confirmation is considered to be in force and we will enter a long trade. Once a wave 3 below the price bar changes to a wave 4 marked above the price bar we will then assess the following indicators to confirm that a short trade should be made:.
As long as the both occur at some point prior to the wave count being something other than 4, then a confirmation is considered to be in force and we will enter a short trade. Trade Exit Plan 1. If stop-loss order is hit then the entire trade is exited. If the three-day RSI reaches 85 or higher for a long trade, or 15 or lower for a short trade, or if the wave count changes from 4 to 5, we will sell half and adjust our trailing stop as follows:.
If the wave count changes to something other than a wave 5, we will simply exit the trade on the next day. Example Setup and Trade In Figure 1 we see the setup for a short trade. On the most recent trading day, the blue number 4 first appeared above the price bar.
Prior to the day, a blue number 3 had appeared below each price bar for the past several days. This suggests that a wave 5 decline may be setting up. Below the bar chart you can see that the three-day RSI ticked lower on the day and that the day CCI is in negative territory. This confirms the setup and constitutes a sell short signal, so we also calculate our stop-loss price by adding three times the average true range over the last three days to the current day's high price.
In Figure 2 you can see that roughly a month later the three-day RSI registered a reading below As a result, on the next day we would have bought back half of our position at Cable remains locked close to its lows and no evidence yet to support the idea that the downtrend has resumed. We want to see an impulsive decline below the most recent swing lows to gain confidence in the main hourly count.
As expected the euro moved toward the downside, reached both targets, and exceeded the second target by 7 pips. This part of the decline is now complete, but the decline as a whole looks like it needs one more dip lower.
We continue to look for signs to support the idea that the downtrend has resumed. Even though the decline is more in line with the main hourly count, the decline is — so far — in a three-wave pattern. We want to see an impulsive decline to gain further confidence in the bearish case. On the other hand, the alternate count expects that wave B blue has higher higher in store before giving way to a decline in wave C blue.
As expected the euro moved toward the downside and reached our targets, but the decline is now too long for the main count to remain preferable. The next most fitting count is that the entire movement since the low of August 14 is part of a flat correction.
The market service that never makes mistakes does not exist.
Once a wave 3 below the price bar changes to a wave 4 marked above the price bar we will then assess the following indicators to confirm that a short trade should be made: