Category Archives: Education

Learn Elliott Wave – Spot The Mistakes | 18th October, 2017

Another brain teaser to test your Elliott wave knowledge:

S&P500 2017
Click chart to enlarge.

I have tried to make it a bit easier by violating only core Elliott wave rules and making the mistakes really bad ones. Price points of all waves are given so you can calculate lengths and look for the mistakes.

You can participate by either posting a chart or comment pointing out the five deliberate mistakes, or post a chart where you fix the wave count to remove the mistakes. It’s up to you. If making a comment, please refer to the degree of labelling the mistake is in.

I encourage all members who find this a bit challenging to really give it a go. This should be a great exercise to really hone your Elliott wave skills.

Hints:

There are two mistakes which violate the same Elliott wave rule.

One mistake is in a corrective structure, and to me it looks very obvious.

Another mistake violates a core Elliott wave rule, but it is a matter of judgement as to how the wave may subdivide on a lower time frame.

Another mistake violates a core Elliott wave rule, probably the most important core Elliott wave rule which should absolutely never be broken, ever.

Answers will be posted tomorrow after tomorrow’s analysis is published. You have 24 hours. Have fun!

Published @ 04:30 a.m. EST.

Setting Targets Using Elliott Wave | 17th October, 2017

When is it appropriate to use targets that are longer than 1.618?

S&P500 2017
Click chart to enlarge.

SUMMARY:

It is appropriate to use targets calculated using Fibonacci ratios greater than 1.618 (following ratios in the sequence) when:

1. A first wave is very short, and a target calculation using only 1.618 would see the third wave not move far enough for a ratio using a higher degree to be reached.

2. Price reaches the first target using 1.618 and keeps moving through it. Then the next Fibonacci ratio in the sequence should be used.

3. The particular market analysed often exhibits extreme Fibonacci ratios such as 6.854 and 11.09. Bitcoin is an example of such a market. This behaviour can be determined by Fibonacci analysis of completed waves.

EXAMPLE:

The chart above shows a fairly typical example of a third wave for Gold.

Here, minor wave 1 was relatively short. The first target using 1.618 for minor wave 3 would have been reached about 1,488. The structure was not complete there, unless the end of minute wave i was labelled as minor wave 3. But it did not exhibit a very strong increase in downwards momentum, so although that could have been the end of it (and was suggested to me at the time) that would not have looked right.

Intermediate wave (3) exhibits an extreme Fibonacci ratio to intermediate wave (1). Intermediate wave (1) was very short. As intermediate wave (3) unfolded, it could have been labelled complete at the low labelled minute wave iii. The strongest argument against such labelling would have been that selling climaxes are usually the end of a third wave within a third wave, and not often the end of a third wave of a larger degree.

Both of the fifth waves to end minor wave 3 and intermediate wave (3) exhibit ratios of equality in length with their counterpart first waves.

Published @ 02:11 p.m. EST.

3 Most Important Things to Consider for Candlestick Reversal Patterns | 11th October, 2017

This daily chart of the S&P 500 identifies 16 candlestick reversal patterns. Only reversal patterns are considered here, not continuation patterns.

S&P500 2017
Click chart to enlarge.

The first #1 and #2 patterns are both Three White Soldiers. Pattern #1 comes after a short sharp fall in price, so it may be considered a reversal pattern. But pattern #2 comes within an upwards trend, so it is more of a continuation pattern here and would not be considered a reversal pattern as there was nothing to reverse.

This leads to point number 1:

For a reversal pattern to have meaning there must be something to reverse. A bullish reversal pattern should come after a decline in price. A bearish reversal pattern should come after a rise in price.

Pattern #3 is an important reversal pattern and it does come after a steady rise in price. It correctly predicted a consolidation.

This leads to point number 2:

Reversal patterns mean a reversal of the prior trend to the opposite direction or sideways. They do not only mean a complete 180 degree reversal; sideways is a direction too.

The Shooting Star at #4 does not come after a bullish rally. It comes within a consolidation, so it should not be considered a reversal pattern. This is another illustration of point number 1.

Likewise, the Bullish Engulfing pattern at #5 comes within a consolidation. There is nothing here to reverse.

The Piercing Pattern at #6, however, does come after a short sharp fall in price, so it should be considered a reversal. It did correctly predict the following 7 days of upwards movement.

This leads to point number 3:

Reversal patterns make no comment on how far price may travel in the new direction.

The Morning Star at #7 is the second reversal pattern at lows after a short sharp fall. Along with the Piercing pattern, it correctly predicted the next rise in price.

However, the Bullish Engulfing pattern at #8 does not come after a fall in price. It comes within a consolidation. There is nothing here to reverse, so it should be ignored.

The Gravestone Doji at #9 is normally a bearish reversal pattern. Its forte is in calling tops. Here, it comes at the end of a bearish movement, so it is out of context. It cannot be calling a reversal in a bull move as there was no bull move prior to the pattern.

At #10 the Bullish Engulfing pattern does come after a reasonable fall in price, so it should be considered a reversal pattern. This pattern was followed by a persistent bullish move.

Like the Gravestone Doji, the Dragonfly Doji at #11 is out of context. Here, it is at highs and within a small consolation. Dragonfly Doji are bullish reversal patterns when they occur after a bearish move, but this one does not.

Another pattern within the consolidation at #12 should be ignored. There is no bullish move here to reverse for the Bearish Engulfing pattern.

The Hammer pattern at #13 does not come after a reasonable bearish trend; it was only the second day of a fall in price. There is nothing to reverse, so it should be ignored. The long lower wick is still bullish though. As a Hanging Man pattern it would require bearish confirmation in the following candlestick, which did not come.

The Hanging Man at #14 though does come after a bullish move. But the bullishness of its long lower wick still requires bearish confirmation, which did not come. The following candlestick is quite the reverse; it is another bullish signal. As #15 comes within a small consolidation, it may be considered as a bullish signal.

Finally, the Piercing pattern at #16 comes after a long upwards trend, so it should be considered as a bearish signal.

Published @ 05:57 a.m. EST.

Trading With Gaps – A Case Study Using AAPL | 10th October, 2017

Following on from the last two education posts on gaps here is an example of practical trading application.

Google 2017
Click chart to enlarge.

This daily chart of AAPL data shows at least 11 gaps.

After a period of consolidation gap #1 appears. It breaks above an upper range from a consolidation, so it should be considered a breakaway gap. A position may be entered in the direction of the gap, with a stop just below the lower edge of the gap. Breakaway gaps should not be closed, so the lower edge should offer support if there is a new upwards trend.

After some upwards movement price curves down to test support, but the breakaway gap remains open and so should long positions.

Thereafter, another gap at #2 indicates another breakaway from the last consolidation. Stops may now be moved up to the lower edge of this gap.

Another gap at #3 may be initially expected to be a measuring gap, which would give a target at 119.28. If this is a measuring gap, it should not be closed for a long time and the lower edge should offer support; stops may again be pulled up to just below it. But this gap is closed three days later, which should trigger an exit from a long position opened after gap #1 and which should yield a reasonable profit.

Gap #4 may initially be expected to be another breakaway gap after another small consolidation. It may trigger another long entry, but the gap is closed six days later for a small loss.

Gap #5 is not a breakaway below support and should be considered a pattern gap. These are most often closed. This should not trigger any new position.

After several days of falling price, a trend line may be drawn across resistance. When the trend line is breached, a long position may be entered or traders may choose to wait for another gap. There is not another gap until a few weeks later at #6.

Gap #6 may be taken as another breakaway gap after a small consolidation. This may again signal an entry in the direction of the gap with a stop just below the lower edge. Four days later price curves down to test support and the gap remains open.

Another large gap opens at #7. Given the size of this gap the appropriate measure for the movement before it may be the last reasonable swing low on the 14th of November. This gap looks like a measuring gap. A target may be calculated from the base of the movement prior to the gap and added to the upper edge of the gap. This gives a target at 144.32.

Stops may again be moved up to just below the lower edge of the gap; it should provide support as measuring gaps should not be closed. Now some profit is protected on a long position with a target at 144.32.

Gap #8 opens up prior to the target being met. This should be expected to be another measuring gap until proven otherwise. Stops may again be moved up to just below the lower edge of the gap to protect more profit. The new target would be calculated from the last rise from the last gap and added to the upper edge of the gap, giving a new target at 148.02.

But this gap is closed six days later signalling it was an exhaustion gap and not a measuring gap. Positions would then be closed for a reasonable profit.

After some further consolidation in which trend lines may be used to find another entry, or traders may wait for another gap, the next gap opens up at #9 a few weeks later. Again, this comes after some consolidation, so it may be either a pattern gap (it may be considered within a consolidation) or it may be a breakaway gap. A position may be entered in the direction of the gap with a stop just below the lower edge. If it is a pattern gap, a small loss may be incurred. If it is a measuring gap a good entry point for the next upwards movement may be found.

Price curves down to test support at the upper edge of the gap two and three days later. The gap remains open and long positions remain open.

Another gap opens at #10. This may be another breakaway gap, but coming so soon after the last one it may also be a measuring gap. The move prior to it is small, so the target would be calculated from the move prior to the gap and added to the upper edge of the gap, giving a target at 146.08. This target is met the following day, so positions may be closed for a profit. Two days later the gap is closed indicating it is an exhaustion gap and not a measuring gap. No new positions should be entered as price may be entering a larger consolidation.

Another gap opens up at #11 on a strong upwards day. This may be another breakaway gap, so a new position in the direction of the gap may be opened with a stop just below the lower edge of the gap.

The last gap opens up at #12. This may be another measuring gap, so it should not be closed. Stops may be moved up to just below the lower edge of the gap, which would now protect some profit. A target calculated from the rise prior to the gap added to the upper edge of the gap gives a target at 159.69. This target is not met and the gap is closed three days later as the stop is hit yielding another profit.

Conclusion: Gaps can be useful for trading in markets where they appear regularly. Some patience is required in holding onto positions, which may be underwater for the first few days, but overall this approach may yield more profit than loss. Small losses are inevitable and risk must still be managed.

Published @ 05:32 a.m. EST.

4 Different Types of Gaps | 4th October, 2017

Not all gaps have to be closed. So how can we know which gaps are going to be filled and which ones aren’t? The answer lies in what type of gap the gap may be.

Google 2017
Click chart to enlarge.

The above chart of Google shows daily data.

Equities more commonly have gaps and session only data of indices often does too. Forex rarely has gaps because forex markets are open 24 hours.

The four different types of gaps are:

1. PATTERN GAPS

These gaps are the ones which are almost always closed. Only the very last gap within a consolidation may not be closed.

These gaps suggest a congestion area is forming. They are not useful in trading.

2. BREAKAWAY GAPS

These are the most profitable gaps. After a period of sideways movement draw trend lines to determine support and resistance for the consolidation. A breakout above or below the zone accompanied by a gap signals the end of consolidation and the return of a trend.

Breakaway gaps are rarely closed within any reasonable time frame. They may be used as areas of support or resistance to set stops.

If the gap is filled reasonably quickly, then it is unlikely to be a breakaway gap.

3. MEASURING GAPS

These are gaps that occur within a clear trend. Assume such a gap is a measuring gap until proven otherwise. Proven otherwise means until the gap is closed.

Measuring gaps are not closed within any reasonable time frame. They may be used as areas of support or resistance, and to place stops. They may also be used to set targets. They often occur about mid way within a price run, so calculate the distance of the pole prior to the gap and add that to the end of the gap to give a target.

4. EXHAUSTION GAPS

These gaps are closed within a relatively short time frame. As soon as the gap is closed, it indicates an end to the price run and the start of either a trend change or a period of consolidation.

Exhaustion gaps are filled within a few candlesticks.

Published @ 04:53 p.m. EST.

All Gaps Have to be Closed – Myth or Fact? | 3rd October 2017

The answer to the question is in the charts. If gaps can be seen, which were not filled, then not all gaps must be filled.

SPX 2017
Click chart to enlarge.

Some markets have more gaps than other markets. Gold is a global market and rarely has gaps at the daily chart level, but it may have gaps occasionally at the hourly chart level and below.

The S&P500 is a good example of a market with gaps.

There are two examples of gaps not filled in the daily chart above for the S&P500, from price movement during February of 2017. To this day, 8 months later, these gaps remain unfilled.

Published @ 05:10 p.m. EST.

Best Fit Channels | 26th September, 2017

If an Elliott channel does not fit a movement, then a best fit channel has to be drawn. The best fit is a channel which contains most or all movement within a trend and is tested the greatest number of times.

Example:

Gold 2017
Click chart to enlarge.

A channel drawn about this impulse using either of Elliott’s techniques does not contain all movement. Therefore, when compared to a best fit channel, Elliott’s channel drawn this way may not be as reliable in indicating when the movement has been over and there may have been a trend change.

Gold 2017
Click chart to enlarge.

Redrawing the channel as a best fit now contains all the impulse. Therefore, for this impulse on this chart, this best fit channel should be a more reliable and more conservative indicator of a trend change.

Published @ 04:36 a.m. EST.

2 Early Channel Techniques | 21st September, 2017

Channels drawn using Elliott’s techniques, outlined here, cannot be drawn until a reasonable amount of a wave has completed. There are two techniques to draw a channel about a new movement earlier.

1. BASE CHANNELS

Gold 2017
Click chart to enlarge.

This is the earliest channel that can be drawn about a new movement. This channel was drawn at the end of minor wave 2.

Base channels have two main purposes:

1. As the wave progresses the edge which is opposite to the main direction of movement should provide support or resistance. Here, the wave is down and the upper edge should provide resistance to bounces along the way down. It is the opposite for a bull wave; the lower edge should provide support for pullbacks along the way up.

A sloping trend line offering support or resistance can be used to place trailing stops.

2. A third wave may be identified or confirmed if it has the power to break through the base channel in the direction of the trend. A third wave should have the power to break above resistance at the upper edge of a base channel for a bull wave. Here, minor wave 3 should have the power to break below support at the lower edge of the base channel.

2. ACCELERATION CHANNELS

Gold 2017
Click chart to enlarge.

Later on in the development of a wave the base channel may be redrawn as an acceleration channel. This may be done after a third wave shows enough power to break out of the base channel in the direction of the trend, or it may be done earlier.

Acceleration channels are redrawn each time price makes a new extreme in the direction of the trend.

When a third wave is complete, then this channel is an Elliott channel (drawn using the first technique).

Acceleration channels have one main purpose:

1. To show where corrections within the trend find support or resistance, on the side opposite to the trend.

The side opposite to the trend may be used to place a trailing stop when trading the trend.

Published @ 06:22 a.m. EST.

3 Elliott Techniques For Drawing Trend Channels | 20th September, 2017

The three basic Elliott Wave channels are:

1. FIRST TECHNIQUE – IMPULSE

Gold 2017
Click chart to enlarge.

Once enough structure is complete to begin to draw an Elliott channel (about one third to halfway through a wave) use the first technique.

A trend channel drawn using this technique may show where the fourth wave may end. If the fourth wave is contained within the channel, then the fifth wave usually ends either midway or at the opposite edge of the channel. While most markets behave this way, commodities can be different. Commodities often exhibit swift and strong fifth waves which overshoot channels, as in this example.

When the channel is breached by subsequent movement in the opposite direction, it indicates the wave is over and a trend change may have occurred.

2. SECOND TECHNIQUE – IMPULSE

Gold 2017
Click chart to enlarge.

If the fourth wave is not contained within a channel drawn using the first technique, then redraw the channel using Elliott’s second technique.

This redrawn channel may show where the fifth wave may end: either mid way or about the side opposite the fourth wave.

When the channel is breached by subsequent movement in the opposite direction, it indicates the wave is over and a trend change may have occurred.

3. TECHNIQUE FOR A CORRECTION

Gold 2017
Click chart to enlarge.

If the movement is expected to be a correction, then it may be contained within a channel. Most corrections are contained within channels, but a few such as expanded flats are not.

The channel may show where wave C ends, either mid way or at the edge of the channel.

When the channel is breached by subsequent movement in the opposite direction, it indicates the wave is over and a trend change may have occurred.

Published @ 06:16 a.m. EST.

2 Steps to a High Probability Trade Set-up | 15th September, 2017

This is my favourite trade set up. Here’s what to look for and why.

Gold Monthly 2017
Click chart to enlarge.

To begin, look for a trend line which has strong technical significance. In deciding how strong or weak a line is use these guidelines here.

This trend line on Gold’s monthly chart is drawn as a bear market trend line as illustrated here.

Gold Daily 2017
Click chart to enlarge.

Zooming on at the daily chart level to see exactly where the line sits, we can see that price is not sitting perfectly upon it. That may be because this trend line extends so far back, to September 2011. The general idea does appear to be working here today though.

This is the trade set up:

Step 1.

Look for a breach of the trend line. If this is achieved on strong volume, then have more confidence in the breach. StockCharts data does show very strong volume for the 5th of September, which is the daily candlestick on their data that would have been the day of the breach.

Step 2.

Look for price to curve around and back test support at prior resistance (or in a bear market resistance at prior support). Enter in the direction of the larger trend when price tests the trend line.

This set up takes time. In this case a wait of 7 to 8 days after the initial break above the trend line.

Today, the long lower wick and bullish engulfing candlestick pattern offer a little more confidence in this set up.

Why is this such a good trade set up?

With a technically significant trend line, the set up offers an entry point to a trend which traders may have confidence in. The more significant the line, the more significant the breach.

Stops may be set quite close by. Allow a little room for overshoots, and for longer held lines slightly larger overshoots, but stops may be closer than the last swing low or high. This reduces risk.

Published @ 01:15 a.m. EST.

Scale – Arithmetic or Semi-Log? | 30th August, 2017

The choice of what scale to use on your charts makes a big difference to how trend lines sit. Which scale is correct?

Gold 2 Weekly 2017
Click chart to enlarge.

The chart above shows Gold 2 weekly on an arithmetic scale. Notice the bear market trend line has been breached, but did not show where price exactly found support and resistance in the process.

Gold 2 Weekly 2017
Click chart to enlarge.

The chart above shows Gold 2 weekly on a semi-logarithmic scale. So far price remains below the bear market trend line.

An arithmetic scale is best used for short term price movements. But for long term movements a semi-logarithmic scale is more correct, particularly for markets like Gold which can exhibit blow off tops and selling climaxes.

Any long term movement a year or more should always use a semi-logarithmic or ratio scale.

From Magee (“Technical Analysis of Stock Trends”, 9th edition, page 11):

“Our own experience indicates that the semilogarithmic scale has definite advantages in this work; most of the charts reproduced in this book employ it… Percentage relations, it goes without saying, are important in trading in securities… certain trend lines develop more advantageously on the ratio scale.”

From Pring (“Technical Analysis Explained”, 4th edition, page 68):

“Arithmetic scaling is not a good choice for long-term price movements, since a rise from 2 to 4 represents a doubling of the price, whereas a rise from 20 to 22 represents only a 10 percent increase… For this reason long term price movements should be plotted on a ratio or logarithmic scale. The choice of scale does not materially affect daily charts, in which price movements are relatively small in a proportionate sense. For periods over 1 year, in which the fluctuations are much larger, I always prefer to use a ratio scale”.

Published @ 04:28 p.m. EST.

Volume and Breakouts – Is it Necessary? | 11th August, 2017

This chart was published two days ago. At that time, it was warned that the possible upwards breakout of the 8th of August lacked support from volume and may turn out to be false:

S&P500 Daily 2017
Click chart to enlarge.

That was proven correct. The strong downwards movement from the S&P comes on a day with an increase in volume. This is a classic downwards breakout.

When a downwards breakout has support from volume, that adds confidence in it. Downwards breakouts do not require support from volume; the market may fall of its own weight. Price can fall due to an absence of buyers as easily as it can from an increase in activity of sellers. But when volume supports downwards movement, it may be more sustainable, at least for the short term.

This downwards breakout was predicted by strongest volume during the consolidation being a downwards day.

This volume analysis technique looks at the presence or absence of support from volume on the breakout after a consolidation period to tells us how reliable the breakout may be.

Published @ 12:17 a.m. EST on 12th August, 2017.

Volume and Breakouts – Is it Necessary? | 9th August, 2017

After a consolidation price will break out. The presence or absence of support from volume on the breakout tells us how reliable the breakout may be.

Gold Daily 2017
Click chart to enlarge.

Pennant patterns are one of the most reliable continuation patterns. But in an upwards trend the breakout should have support from volume.

For price to keep rising it requires increased activity of buyers. Upwards breakouts that do not have support from volume are suspicious.

This upwards breakout comes on a day with slightly higher volume, but the balance of volume for the session is downwards. Stronger volume during the session supported downwards movement, not upwards.

The breakout is suspicious and may turn out to be false.

While volume is important for upwards breakouts, it is not so important for downwards breakouts. The market may fall of its own weight.

Published @ 04:47 p.m. EST.