Today's Elliott

Jordan Craw

Many of the complex techniques, used in Today’s market analysis, have been practiced since the early part of last century and beyond - well before the advent of computers and trading software. Moving Averages of stocks were plotted over hand drawn charts, where there was no ability to quickly modify time frames or delete unwanted trend lines at the touch of a button.

Elliott Wave Theory is one such technique that has stood the test of time and found its way into a number of trading software packages. The Elliott Wave Theory was developed by R.N. Elliott, based on his studies of wave movements. Most are happy with the idea that markets rarely trade straight up or down without pullbacks. Following on from this, Elliott concluded in essence that markets progress through a given trend in a series of five movements or waves.

Below is an example of a five-wave count on the XJO, based on a weekly chart from 1995 to 2001.

click chart for more detail

The important thing to note, is that Elliott counts can be very subjective. A correct count to one practitioner could well be incorrect to another… and the funny thing is, they could both be right to a high degree. For instance, it is easy to question the above as to why the 3 wave ends where it does or why the last pullback on the chart is not a 4. However, the most important thing to take away is that, like any trading method, you need clearly defined rules to remove subjectivity. Elliott defined filters and parameters in order to do this at a basic level. However, the complexity of the theory as a whole still leaves a subjective element for many.

In my opinion, the easiest way to apply Elliott is via a technique or software package that uses only the basic components of Elliott. The key there, is that the counts must be consistent. In turn, the ability to label every single market movement is sacrificed. Instead, only recognized patterns are plotted and traded – this is the case with most other approaches anyway.

As wave counts can be hard to match to a market until the five-wave has been completed, the last movements of the wave are generally the easiest to trade. Note the arrows marketed on the 5th wave and the retracement from 5 back to 4. Based on testing, trading these moves offers the most consistent trading results.

A combination of filters and entry triggers should also be used to quantify potential trades and limit false breaks. These can range from Oscillator to MACD or Moving Average patterns and signals.

Last, but not least, here is a weekly chart of the XJO up to the current week. As you can see the movement so far suggests it is currently in a 3 wave. If a retracement occurs and confirms wave 4, we would then be set for another bullish move up.

click chart for more detail

Elliott wave, like all analysis, can be subjective. Removing this subjectivity is the key and challenge all in one. In the coming weeks we will discuss examples of Elliott Trading Systems in further detail. Until then…

Happy trading…

Jordan Craw