Saturday, December 5, 2015

Defined Risk

With Friday's large point move, the jury is still out on whether a sideways triangle or a more forceful move upward is in progress. The daily triangle we are referring to was posted on 11/22 and again on 12/3 in this blog, and elsewhere.

Per the Elliott Wave Principle, triangles can never be 'called' until all five overlapping waves are in place: they can only be 'proposed' until then. The reason is that triangles can morph into a series of 1-2-i-ii, upward. That is because the waves in a sideways triangle contain higher lows.

If that occurs, so be it, and it's on to a structure that better defines the path of the wave. Psychologically, it's interesting how bearish sentiment was on Thursday's down move, and how quickly people turned to say 'wave three' up. And that may be the case : structurally the SP500 is still in a bull market until proven differently.

At times like this it is often more useful to concentrate on the "hard right-hand edge of the chart", where the decisions need to be made, rather than wallow on the pre-defined left-hand-side of the chart where all the "Elliott Wave degrees", and "wave labels" are located, and see what we can see.

The chart below shows only one way to count the movements in the 15-minute SP500 over the last three days. A proposed Elliott wave count is shown IF we are still in the triangle structure.

First, there are five waves down to an 'a' wave. Live and in real-time, we counted down the Wednesday waves as circle-1, 2,3, and 4, and said the fifth wave could easily extend - which it apparently did. Note that the entire sequence down to the 'a' wave is in one channel, and ends with no divergence on the EW Oscillator.

Then, there is the up move beginning late Thursday and into Friday. Notice, for the waves we can see, the upward channel has already been broken to the downside. While this is not fatal for an upward move, it is a bit of a warning sign, and allows us to review an opportunity. Right now, the upward move is just a bit over a 78.6% retracement of the downward move. This is still within the range of an upward 'b' wave as shown. Further, the move did end on a slight divergence with the Elliott Wave Oscillator.

Given,  that a triangle in progress should have a downward sloping trend line, the upward move allows us to posit that the downward move within the daily triangle circle-c wave may fall within another, larger, downwardly sloping parallel. If it does, we can limit the risk on a downward trade by recognizing that price movement from the last price to the high is about 2 S&P points, or about $100 in risk - a very small risk compared to margin of a futures contract.

Whether you analyze the chart the same way, is up to you. Whether you prefer to short the trade and limit your risk to the prior high at 2104, and assume a 7 point risk (about $350) is also a decision that is up to you. We are not telling you to take the trade, or advising you to do it. All decisions are yours. We are only illustrating how Elliott wave theory can be used to set the defined parameters for a trade. In this case, if we have counted correctly, the risk is $100, and the reward would be back down to the prior low around 2040, or a reward of 50 points or $2,500, or a 1 : 25 risk : reward ratio at it's best. Or, alternatively, there is a 1 : 7 risk-to-reward ratio at it's worst and that is even if we have not counted the upward wave correctly (or we have counted it correctly for what we can see, but there is more to come that we cannot yet see).

Furthermore, it is also possible to consider the implications of a non-triangle count, and realize it would also be an excellent location to set a stop & reverse trade. With either $100 of risk, or $350 of risk, then if the pattern is violated to the upside, it is likely all of the loss of the stop being hit could be recouped in a much stronger wave higher - if the 'proposed' triangle is broken to the upside.

If you are not familiar with why risk and reward is an important concept in setting trading decisions (instead of "wave counting" decisions), we encourage you to review the video on the Tutorials page of our web-site. The video is the Top Ten Technical Indicators by Thomas Long of


  1. Thanks Joe! Your posts really help support and reinforce my own learning and understanding.

  2. Note that as of Dec 10th, pre-market the 2040 target level was reached yesterday. In the example above, Elliott wave theory would suggest that at least partial profits - if not full profits should be taken - capturing most or all of the $2,500 per contract. The fifth wave down of (c) of circle-c 'could' truncate in a triangle, or, your own situation could interfere with taking profits before the potential triangle would whip-saw again. Again, this is not trading or investment advice - just an example of what Elliott Wave theory would recommend.

  3. Hi Could you please explain how did you mark wave (4) of circled A. I am trying to understand how to mark two waves in a single candle like you did.If there are any guidelines to understand please share. I have been looking for this information but didnt quite get it. Hope you could help. Thanks