Are You Well-Capitalized?

Every so often readers ask about trading in association with Elliott Wave counting - and not just the pure discipline of Elliott Wave counting. To that end, previously I developed a paraphrase of Ira Epstein's publicly available guidelines for trading (link below this article). As you probably know by now, Ira says never to go naked short above the 18-day SMA, and never to go naked long below the 18-day SMA, along with a number of other guidelines regarding Bollinger Bands and the daily slow stochastic.  But is there something more formal or related to Elliott Wave Counting in particular? 

For those really & sincerely interested in this topic I will include a real-time, real-life example after the video below. But the video below is one of the best videos overall on trading with Elliott Wave done by a man with serious trading credibility - Master Trader Bill Williams. If you will watch this video through and through, you will get an appreciation for trading that very, very few have. The video is a bit more than an hour, and you should watch it when you have the time, and the mood to really digest it.

I have watched this video about eight times now. And it includes a much better description of markets, market psychology, and trading technique than you will find in any of the standard EW textbooks. IF you make a study of the video and evaluate it critically you will find some gems and, yet, some topics are glossed over. In order to deal with some of the topics that are glossed over, I will show you this current real-time trading example. The chart is daily WTI Crude Oil futures (CL).

The chart includes most of Bill Williams key indicators. It has on the bottom in the indicator panels the Elliott Wave Oscillator (or Awesome Oscillator, known as EWO or AO) and the Bill Williams Accelerator - which is the 5-period simple moving average of the EWO/AO which is known as the AC. The chart pane shows the "Balance Line" in blue which is the chaos price attractor. I use the EMA-34 and find it superior as it doubles as a wave-counting tool.

Further, you will see the Bill Williams up (green triangle) and down (red triangle) fractal indicators. The basic idea is one buys fractals above the balance line, and one sells fractals below the balance line once they are "hit" or traded though. These are Bill Williams "blind-chicken trades" in the video. So, if you have watched the video, you can follow the progression of fractal-hits and sells as CL progressed lower. I won't go through the progression. If you are serious, you should reproduce this chart, do this as an exercise, keep track of the profit and loss, etc. What I will do is comment on some of the items Bill glosses over a bit.

Regarding the Williams Trading System

You must be well-capitalized! Look - after a while Bill got rich beyond what some of us can dream of. He was well-capitalized. When he says that you take the fractal hit, and then "you must trust the market like a religion", or "you must be ok with it", what he is really saying is that you must have enough trading capital to be comfortable in the trade and not care which way the market goes. 

Look at that first fractal hit below the balance line at the red arrow. After just three daily bars it is immediately retraced by about 62%. And the retrace lasts almost 10-days. So, either you must have the capital to withstand the retrace OR your initial position must be small enough to withstand the time and price in the retrace. Alternatively, you can use a rule to wait until AFTER the retrace following the initial fractal hit to give the retrace time to work out & then initiate the position. Said another way, "Patience can be part of your trading capital!"

Watch the Fibonacci ratios like a hawk! Bill doesn't address the Fibonacci ratios in the video. I tried to in The Eight-Fold-Path Method. Notice how wave (iii) in daily CL hits rather precisely at 1.618. The Fibos might be used as a profit-taking target or a warning to 'lighten up' - depending on your preference, profit built up in the trade and/or trading style. Notice how the potential triangle comes back very precisely to the 100% Fib (Fibonacci ping-pong?). 

This can lose money. Bill says this in the video. If you get in a range-bound market, you run the risk of getting whipped until you recognize it is sideways price action. So, look at the above chart. Notice the potential triangle! Notice how there are fractal hits above the balance line - which, if taken - would cause losses. This is where the Principle of Equivalence comes in, and why I developed it. We all know triangles can bust. If you haven't had one bust on you, you haven't been trading long enough. So, we don't assume and try to follow the fractal breaks. We count waves and see if there are zigzags or impulses inside that structure. We try to see whether it will bust up or bust lower, and, if lower, we follow the fractals lower. 

Premature reversing. In the video Bill says, "when we see the momentum slowing down, we start entering orders to go in the opposite direction". In the above chart, this would be like entering orders to go long inside the triangle, or inside the fifth wave down. OK. Remember, he is well-capitalized. For the small trader this can be a mine-field. I recently saw a video done by Jeffery Kennedy of EWI where he called a fifth wave after a triangle, and you know what? Even given this expert wave-counter, the fifth wave kept extending, and extending, and extending. Do you want to be in this situation? 

Volume & candles. The Bill Williams indicator that is not included in the chart above is what he refers to as squats, greens, fades & fakes. You are encouraged to investigate this more on your own, but the basics is this is how price reacts to volume. Personally, I find plotting volume near the ends of waves, and looking for simple candle formations and confirmations of highs or lows to be a bit more useful. You'll have to make your own decision which you like better.

We don't read any current news. OK. This conflicts directly with Ira Epstein's guidelines that he doesn't trade through major news reports (like Payroll Reports, FED interest rate announcements, etc.). So, here again this indicates that Bill had enough capital to sit through market-moving reports. Just sitting idle through a FED announcement today can cost one dearly if they get it wrong.

Intraday Filtering. IF you are a day trader, you may want to further modify Bill's system so that if you are trading a one-hour chart, say, you do not take any trades that conflict with the location of the larger 18-day SMA. Remember, the smaller the timeframe, the fewer "traders there are in the market at that moment" to make decisions or form fractals that are meaningful or significant. Yes, the market is fractal, but every fractal does not mean the same thing or carry the same weight of opinion.

In Summary. Bill's video and method are exceptionally helpful in understanding an Elliott Wave trading method. But there are some items that are poorly explained. One of the biggest is your position sizing and your level of trading capital. In the above example, it helps to look at your level of capitalization like this: you should not compare your trading capital level to mine. You should recognize - for the example in the above chart - that your competitor is not me. Your competitors for CL are Goldman Sachs, BlackRock, EWI and OPEC! Do you have enough capital, including patience, to compete with them, or can you keep your position sizes small enough that you can handle the adverse market movements with ease?! It is the position sizing & capitalization that allows Williams to trade in that calm, relaxed manner that he prefers. What do you prefer?

Nothing in this analysis is to be taken as trading or investment advice. It is being documented in one sense to have another quick reference for the future.

Have an excellent rest of the weekend.

TraderJoe

P.S. Here is the link for the paraphrase of Ira Epstein's Guidelines for Trading (LINK).