Currencies and Elliott Waves
In my trading there have been some tools and techniques that have taken prominence in my analysis of markets. Whilst there are many tools available to traders, I have generally restricted my toolkit to the works of Gann and Fibonacci.
Indeed, I have found through practical experience that traders can have too many signals, indicators, etc. I have made a deliberate strategy to not have too much on my charts in order to not overanalyse the market.
One of the tools that I use fairly loosely is The Elliott Wave theory, not because it isn’t applicable or that it is too hard to follow, but again I don’t want too much on my charts. The Elliott Wave theory can be broken down into smaller time frames with waves, sub waves, minuettes and sub minuettes…confusing to the untrained eye. In essence, the main theory of five waves per trend followed by three waves of counter trend is how I use this theory.
I am watchful for the Elliott wave patterns as they are based on Fibonacci numbers as well as the ranges counts that Gann used heavily, so I already have a natural affiliation with Elliott with my current techniques.
The rules I apply are simple:
- It must have a 5 wave structure and be followed by a 3 wave counter trend.
- Wave 3 of the 5 wave structure must not be the smallest of the 5 waves.
- The bottom of wave 4 must not go below the high of wave 1.
- Wave 1 and wave 5 must be identical in either time or price or exact variables of each other in time or price.
- The end of the correction phase at point C must be an exact Fibonacci retracement or a Gann retracement factor of the 1 to 5 wave pattern.
These are my interpretation and limitations of the Elliott Wave theory, as designated in the graphic below. As I mentioned there are other rules pertaining to this technique, but due to my existing tools and strategies I have adopted, for the most part, the basics of Elliott’s theory. Any trader must be able to recognise that some techniques or rules seem to fit their personality more than other tools or signals, and adjust the rules to fit their own expectations. Back testing your adjustments is essential but once you are confident that your interpretation will work the majority of the time, then you have a balance you can work with.
Of course there are many who will denounce this theory as unworkable and not relevant to today’s high paced volatile, computer driven markets. On this I couldn’t disagree more. In fact, let’s have a look at the perfect Elliott wave on the largest traded market in the world today, the currency market of the Euro against the US dollar. Surely if Elliott wave theory is valid then it must work in this market of extreme high volume, computer driven robot systems, 24 hours volatile trading…
On Monday, June 7 2010 the Euro value against the US dollar ceased a serious decline, and at this low point of 1.1877 (this simply means there are 1.1877 Euros to each 1 US dollar) traders now reversed their negative thoughts about the Euro and expected either the Euro to gain strength or the US dollar to weaken. As a trader you can analyse market reports, commentary, fundamentals, government policy etc, or like myself and many others you can simply watch the chart for Time, Price and Pattern indications of change of trend or direction. I have marked this low point on the chart as point A.
This low could be very significant in future trading, especially when we see a higher low forming on the chart at 1.2512. Once the top of the previous high at 1.2463 is passed, we now have a higher top higher bottom movement and this clearly signals an end to the bear campaign and a start to a bull run.
My strategy is now to measure the next distance between the highs and the lows and incorporate the rules I outlined earlier for Elliott waves. You can see the highs and lows marked on the next chart.
Now that we know we have a bull market, we can use the information at hand to our advantage.
We measure the difference between the low at 1.1877 and the first major top at 1.2469 and this gives us a range or difference of 592 points or pips as it is called in currency trading. This ‘reference range’ will become important as, remember, wave 1 and wave 5 must be identical or exact variables of each other for a true Elliott wave to be present.
The next high is at 1.2723, and the range or distance from the previous low at 1.2152 is 571 pips.
This cannot be an Elliott wave setup as the rules state wave 3 must be larger than wave 1. So we cannot use this theory to make decisions at this time. However, another top has come in at 1.3029, and the range now from the first higher low at 1.2512 is 877 points, so we now have a larger run than wave 1 which means this new upward movement could be a wave 3 in an Elliott wave pattern.
I have marked this for you in the chart below:
You can see at the high of 1.3029 we saw lower prices creating a new low at 1.2733. Is this now becoming a valid Elliott wave? So far we could have waves 1 to 4. This low at 1.2733 also satisfies another of the rules in that the low of wave 4 must be above the high of wave 1(1.2469).
If we now consider we have a potential Elliott wave pattern on the EURUSD chart, we have a quantifiable price for a major top. This we calculate as follows:
The next low at 1.2733 must now have a rally or range up equal to the amount of the range of wave 1 which we know was 592 pips ( 1.2469 – 1.1877). This means if we get a high at (1.2733 + 592) 1.3325 we have an Elliott wave pattern which consists of the 5 wave structure we outlined at the beginning of this article.
As the market continued on, we can now see in the chart below that indeed we got to our perfect Elliott Wave pattern with a high at 1.3334, only 9 pips out on a daily chart from a repeat of the first range from the June low. This means I can put a short trade in place with relative comfort knowing that this market must now have an ABC correction phase as per the EW theory.
There are some very powerful Gann timing concepts at work here on this chart as well, but if we just concentrate on the Elliott theory, we must have an ABC correction that reaches an exact proportion between the June low at A and the August top.
Again, as this market proves beyond any doubt the validity of Gann, Elliott and co, the market fell into a late August low which was exactly at the half way point between the June low and the August top. This now means I can close out my short trade and go long with a minimal stop loss, again with some ease and comfort knowing that these tools have been so powerful in predicting highs and lows.
In the final chart below, I have overlaid the Elliott Wave structure. Here, on the largest market traded in the world today, a perfect example of the Elliott wave allows the educated trader to make the most of these incredible opportunities present in markets every day.
Knowledge is real power, and anyone can make great money from trading if they simply allocate some time to research the past masters of trading and replicate their guidelines in our markets.
With best wishes,