Sunday, October 11, 2015

Example EW Trade Setup Preparation - US Dollar Index

Disclaimer: Nothing in this post is to be taken as trading or investment advice. This is an example of a trade set up using Elliott Wave theory. Futures trading may not be suitable for all, and may result in loss of some or all capital. Consult your own financial adviser regarding the suitability of any herein contained information relative to your own situation. Any trades taken are solely your responsibility.

Many people have complained that there are "too many options under Elliott Wave Theory", "you show too many changed counts", and, of course, there are famous accounts of bad Elliott Wave calls (that we won't go into here), so "how could Elliott Wave theory be of any use in real trading?" Well, we're going to show you a real situation where the market sends a "mixed message" and see what some of the newer tools of Elliott Wave trading can tell us. I'm going to ask you at the outset, "what do you think you get paid for in trading?" Do you think you get paid to read a newsletter or watch a video and take the person's advice, putting on a trade when you are not really sure "why you did"?

No, you are paid for doing work - doing hard work to try to create an edge for your position that others don't have. If you get paid, it is for clearly defining your risk and your reward, and trying to do as much as possible to capture the reward. The market is not going to hand you money as a retail trader, when it could hand it to a much better capitalized hedge fund manager who has a staff of people, one of whom can doing nothing more than spend all day analyzing your favorite stock, ETF or futures contract, and who has more 'staying power' in almost any market by virtue of their size. And you need to realize that, sometimes, and actually, often, for all this hard work you don't get paid. In fact, just the opposite, the market says, "thanks for all the hard work, but you get to have a loss today." So, if you ready to do some work - under these conditions - then roll up your sleeves, and let's go. Clearly, if you have a full time job, or don't have a few hours a day to put into market analysis, then this style of trading may not be practical for you. That's something you have to decide.

Your Prework - DXZ15
Please take a monthly chart of the DXZ15 or $USD from 2008, forward. Clearly, you can see there are higher highs and higher lows. The chart moves from the lower left to the upper right. We won't show you this chart. It is your work. Now do the same thing for the weekly chart. Again, there are higher highs and higher lows. The chart moves from the lower left to the upper right.

These charts - going from the lower left to the upper right - mean we do not want to take any short trades. We want to trade in tune with the larger picture of the market, and only trade long on pull-backs of smaller degrees than these larger trends.

Daily DXZ15
When we look at the daily chart, below, we see the DX has been in such a pull-back. In fact, the move has been pulling back for six-to-seven months, since last March.

This move is currently all in a "corrective channel". Impulses lower don't form nearly perfect channels and at such shallow angles of descent. As best we can count it, the move counts as a triple zigzag. Since, under Elliott Wave Theory, "triple zigzags are always terminal", it means that this count should end the move lower, and higher prices would be expected. Well, prices have moved smartly off that z wave, low. So, does that mean that we "buy right now?".

No, it means, "we prepare to buy".

So what does 'preparation' mean?

First, we assess the current situation on the daily chart, above. Here are the steps ..
  1. Note that current price at 94.915 is quite a long way from the that August low candle of 92.520 and that would be over $2,300 of risk per contract! That's quite a bit.
  2. Note the position of the daily slow stochastic. While it 'is' in technically over-sold territory, it has not curled up, yet. It can still move lower before crossing up.
  3. Note that the histogram of the Elliott Wave Oscillator is red and still below the zero line.
  4. Note that price is still below the blue EMA-34.
The assessment leads us to conclude that regardless of what we thought before about the Elliott Wave count, price can still go lower before it goes higher.

Second, we assess the Elliott Wave counts that are 'possible' for the waves after the 'z' wave. At this point, we completely forget and ignore any and all waves that are prior to the August low. Here is the first attempt.

Aha, we say. We have a 'gap up' and the makings of a Leading Diagonal wave, and it's wave (iv) has busted the trend line in a 'trap' to get people short, when they should be long. Well, it's 'possible' and price 'can' go down to 94.440 before wave (iv) becomes longer than wave (ii), invalidating a contracting diagonal. So, "I've seen this. It must be the case. I need to rush to my computer and put in an order right now". Um .. no. We just said from the assessment above, there is a good chance price goes lower, first. Is there any more information we can get?

Well, the first thing you need to realize is that the above chart is of the "Daily Nearest Futures". This is one of the most common ways that charting packages display their data: they string together the previous September and current December contract, and look right where that supposed wave (iii) is. Why it's right on the contract expiration week! So, maybe we need to do some more homework.

Let's look at the "December Futures Only" only. This is available on line several places for free.
So, when we look at this chart, what do we see? Well, in fact, there might have been no higher high at all! So, that means a diagonal would not have formed. Now, ask yourself, honestly, "did you think to perform this step to get as much information as you can"? Well, if not, that's OK, you might now know to do it in the future. Taking this action now downgrades the possibility of a diagonal - and upgrades some kind of different count, but now we have to think of what 'that' is. Keep in mind, we have not placed a single order yet with a broker, or spent a dime of anything but our time.

Well, without the higher high, it also means that we don't need to spend much time considering the possibility of 1-2-i-ii. If there was a higher high, we would consider that too. But what count is it that agrees with the assessment we started with, that "lower prices are possible first". Well, here it is.

This would be the possibility that there is a first wave up, 1, and then a FLAT, for a,b,c where the b wave is nearly equal to (single contract month case) or exceeds (daily nearest case) the prior high. This chart would say that the 'c' wave could come down below the the 'a' wave. Well, isn't that interesting!?

That is a case that would both agree with the above assessment, and allow us to cut the risk significantly, if it occurred! Well, that's just ducky, but how do we know how far down the 'c' wave will go? Well, obviously, the gap highlighted with the red circle is a clue. The gap is either going to provide support, or it's going to fill. And, we'll watch to see what happens - patiently. It may be a few days before that happens. But, so what? We haven't spent any money yet.

Yes, I know you are likely impatient: you are looking for a trade you can put on 'this minute'. But stick with me. What can we do in the mean time? How do we know we are likely correct in our assessment of a 'c' wave lower? Well, this is where Bill Williams' tools come into play. Bill's methods call for us to now focus on only the one wave - the 'c' wave lower. From b to c. And now what you do is 'find' the time frame that puts 120 - 160 candles on the chart. Let me say it again, you 'find' the time frame: you don't say, "I've always traded the half-hour chart before, and that's good enough for me." You 'find' the time frame. So, below, when I've done that I find the 2-hourly chart puts 115 candles on the chart. A four hourly chart would put too few (58), and an hourly chart too many (230). So here is that chart.

When we do that, Bill says, "wave iii of 3 will almost always be at the low of the Elliott Wave Oscillator". And, then, you be sure to put the EMA-34 on the chart (or you can use the 'balance line of Bill's alligator : for this purpose they are equivalent). And then the chart begins to "pop to life!"

And isn't that somehow exactly what we have? We have the lowest prices on the lowest oscillator value and the lowest RSI agrees with it. So, we're on to something.

Second, you'll note a downward expanding leading diagonal from 25 Sep to 03 Oct. Because of the overlaps, this otherwise confusing wave sequence really can't be counted another way. Note that within the diagonal, every numbered wave is on an opposite side of the EMA-34 for "good form an balance". Wave v is greater than wave iii, wave iii is greater than wave i, wave iv is greater than wave ii, wave iv overlaps wave i, and they are all zigzag sequences. Picture perfect! So, we assign this structure as wave 1, because it's Elliott Wave Oscillator dropped below the prior EWO low.

Then, we have a zigzag upward, the likely 'a' wave of which doesn't cross the EMA-34 (often a sign of a correction coming), and then the 'c' wave of which does cross the EMA-34. So, we have another numbered wave! Wave 2. And now what do we have? We have a second wave which is a 'sharp', a zigzag. Again, second waves are 'most often' zigzags.

Third, we really suspect a third wave "of some type" because now the Elliott Wave Oscillator is even lower than that first wave lower we cited above.

Further, we have a wave in a channel, and if we use the EMA-34 as the "wave counting tool", then we've had one pierce below it, and only one pierce above it; these are likely waves i & ii, making us, as Bill Williams says, likely in iii. Now, it 'could' be iii of C, but it is 'most often' iii of 3. And, you'll note, we had 115 candles on the chart. There are still up to 160 candles that can complete the wave.

Now, like in Sherlock Holmes, the Hounds of Baskerville, the Elliott Analyst must ask, "what is not on the chart"? or as Sherlock asked, "why didn't the dog bark?".

What's not on the chart is 1) that the channel has not been breached  to the upside, 2) that there is no obvious horizontal or contracting triangle on the chart, and 3) there is no obvious ending diagonal.

Well, since price is not above the channel, there still is no imperative to buy at this level. We need to wait for 'c' to finish. And since wave 1 is a Leading Diagonal, it is very likely that wave 5 will not be a diagonal wave. Since wave 2 is a zigzag, wave 4 could be a FLAT or TRIANGLE. And that will be our clue that price is getting low enough to place a buy order with a closer stop.

We will follow this trade set up in the next few days but before leaving the two hour chart - you see that green triangle above 95.500? That is a Bill Williams, 'up' fractal. With no orders currently in that market, if we should be correct about the triple zigzag, and the market should 'unexpectedly' immediately head higher into a very strong and powerful up wave, then we 'want' to be in that move.

That up fractal is a "buy stop", meaning if price goes beyond it, the buy stop converts to a buy market order, and we would be long one contract at that point. This is key. Suppose our downward analysis is incorrect? Suppose it is just A-B-C down, and the fractal gets hit in the overnight? We don't want to miss that move, and then we would implement 'trailing stops' rather than a 'hard stop' based on a wave count that I will cover in the in follow-up posting. This what is different about Bill Williams than Bob Prechter.

You won't find such clear instructions on 'how' to construct a wave in Prechter. You won't find such clear instructions in how to count a wave in Prechter. You won't find 'clear' instructions in how to use the fractal breaks in Prechter. This is one of the additions you 'will' find in modern Elliott Wave theory. We know you don't have a full appreciation of it, yet. We'll keep you posted with exact details as this wave progresses!

Cheers and enjoy the charts!


  1. Replies
    1. Welcome Mark, and thanks much for saying!

  2. very nice post i just find your blog the way you describe the set up is just great may i ask why you say to use 120 -160 bar when you have the awo
    thank you

  3. Joe your videos are great! Your blog is great! Your analyses are always well thought out and your presentations are clear. I for one am appreciative of all the work that goes into producing such material let alone the time, research and understanding that makes it possible. I hope you don't spend any more time defending your counts or Elliott Wave analysis in general as it detracts from the presentations.

  4. Once again, very interesting, well written, didactic, useful. Thank you !!

  5. I gave up studying Elliott wave a year ago. Thanks to your videos and blog patterns have started to make sense. Very much appreciated.