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PRACTICE THE PRINCIPLES OF ELLIOTT WAVE IN FOREX
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Having the ability to look at a chart and see the corresponding trends or waves in the market will help you determine which side of the market to trade on. One such setup is identifying a higher right-side double bottom form as wave two forms. Remember that it will look like a double bottom or will correct near the 0.618 percent retracement level. Wave two can also retrace 100 percent of wave one; so this information will give you a better idea of how much to risk on a trade. For example, as you see a fourth wave develop, it will be better to wait for a buy signal, rather than chasing the market as it declines and selling short just as it starts building an upside re versal that forms into wave five. Better yet, knowing what the characteris tics of a fifth wave might look like, you can:

• Set profit objectives.

• Use it as a filtering method in order to look for better triggers to sell short as the maturity of a long-term trend starts dissipating.

• Use Elliott wave analysis to help you learn to time entries and exits better.

Identify a potential trend exhaustion level so you learn not to stick around in a trade too long.

Another aspect is to be able to manage risk by helping determine sell and buy stop-loss points as figured by the Fibonacci retracement relation ships and pivot support and resistance calculations. Let's examine a longer term price movement of the Japanese yen, as shown in Figure 7.7, to see how we may have applied Elliott wave theory when combined with Fi bonacci relationships. If the price swings or waves interact and respect the rules as described, then learning more on this subject could help you in fu ture trading decisions. I will demonstrate pivot point analysis integrated with these prices swings and see if this technical analysis method would have been effective. To start, we need to establish a low point, or bottom; and as this chart shows, the low at 101.67 was made on January 21, 2005

As prices move up, we see a breakout to newer highs to 108.92. This is what establishes the first wave, labeled point 1. The R-2 pivot point resis tance target number for April was 108.69. Using the longer-term pivot point analysis is instrumental in the building-block process of nailing down the tops and the bottoms of price moves in Elliott wave cycles.

Then, as a correction occurs, we see the market make a significant de cline back down to 104.20. This is what makes up the second wave, labeled point 2. This price correction reaches, within a small margin of error, the Fi bonacci 0.618 percent retracement value of 104.41. As prices start advanc ing again, it validates that point 2 is an Elliott wave; and we now have wave one confirmed. At this point, we can apply our Fibonacci extension calcu lations of 2.618 percent and 3.618 percent to help identify where this trend may end up. Using the 2.618 percent Fibonacci extension of the distance of wave one gives us an objective of 120.77. The actual high of the entire move made in the fifth wave was 121.39. This was established on December 9, 2005 , 11 months from the low at 101.67!

Once again, using the monthly pivot point analysis from the November data, we have the targeted R-1 calculated at 121.04. While the Fibonacci ex tension tool gave an 11-month warning of what the overall price objective would be, it was the monthly pivot point analysis that came closer in de termining both the actual target numbers and the specific time period. From the fifth wave peak in price of 121.30, the sell-off down to the low, marked point A, was 113.38; and as you can tell on the chart, the majority of that downdraft occurred in just one month. If you were found chasing the market and buying at the top of wave five, you may have found it to be a very painful experience, at least from a financial perspective. In fact, throughout the creation of this Elliott wave pattern, the monthly pivot analysis was extremely useful. The high at point 3 the week of July 22, 2005 , was 113.73; the monthly pivot R-2 target was 113.96. The bottom of the fourth wave, at point 4, was 108.74 the week of September 9; the monthly S-1 calculation was 108.83, less than 9 PIPs (percentage in points)! Pivot point analysis in this example certainly proved to be a useful and highly accurate tool. And I believe that it not only integrates well with many trading tools, but it is highly effective in helping discover peaks and troughs in Elliott waves.

Let's look at a short-term time frame on a different currency and see if Elliott wave theory has merits on shorter-term time frames, as we covered in regard to factual time dimensions. The chart in Figure 7.8 is a 60-minute time period with the British pound. The low on July 17 at 181.72, extended up to form point 1, was established as the beginning of a potential Elliott wave when the low of the second wave was confirmed when the 0.618 per cent Fibonacci correction number held. The distance between the low at 181.72 and the high of 183.29 multiplied by 0.618 percent equaled 182.32. The exact low was 182.25! Again, we see a small margin of error when prices slightly penetrated the support by seven PIPs. The point is that the support targets held. As you look at the chart, see how the market made a rounded bottom and then rallied to form wave one; then as the pullback was made in wave two, it respects the Fibonacci ratios. Also notice that the chart pattern resembles the cup and handle formation as we discussed in Chapter 4.

Once again, here is a perfect example of when you will see multiple indications of a particular move that lines up with various technical analysis methods. I believe the market's job is to move with the least amount of peo ple on the right side of the market. Here is a great example. The market formed a bottom; rallied; and, without warning, sold off in a sharp price break. It is obvious that some traders got burned on the pullback before the market launched into a very defined uptrend. From the low at point 2 to the high at point 3, the majority or the price advance was made in short order. Using the techniques covered in this book can help you stay on the right side of the market. Imagine seeing the 0.618 percent retracement level hold if you were long. You would most likely have had a higher degree of confidence to stay in a long position and would not have been stopped out with a loss right before a major move occurred. Once the first wave was con firmed when wave two held per the Elliott wave theory rules, you could apply the Fibonacci extension rules and determine what the overall price objective might be. The 2.618 percent extension measures up to 1.8583, the actual high on this completed Elliott wave cycle was 1.8601 on July 21.

Again, there was a small margin of error of only 16 PIPs from the actual high and the high predicted using the Fibonacci tool; but it was a small enough margin of error to manage to either exit a trade or look to establish a new short position. Furthermore, the daily pivot point resistance was tar

geting the high for July 21 at 1.8579. Once again, this is where integrating Fibonacci and pivot point analysis with Elliott wave can truly be instrumental by confirming each other and resulting in helping you make the right decision on entering a trade; but combining these techniques can be just as important in helping you with the thought process of when not to take a trade.

POP QUIZ

The chart in Figure 7.9 shows the Fibonacci extension tool highlighting a

2.618 percent expansion of the amplitude of wave one. The chart also out lines the five waves. You will see a wedge pattern that has formed as out lined by the trend lines. If you use what we have learned so far, would this pattern call to action to enter a long position on a pullback or to look for a potential short position?

As you can see in Figure 7.10, the answer should have been to start looking for a selling opportunity. At the very least, you should not be looking at buying at the top of this fifth wave, which was near the Fibonacci

2.618 percent extension. Elliott wave analysis is a very subjective technical tool. There is a lot of wiggle room in determining where wave one starts and where wave five ends or when a new cycle begins. But when you com bine a few simple rules and key observations, these principles really jump out on the charts.

When the market price respects these Fibonacci ratios on the correc tive waves and the extensions target a top of wave five, and then when you apply simple trend line analysis and discover rising wedge formations, once all of these techniques are combined, you really will increase your produc tivity and market-making trading decisions. Pivot point analysis, as I have stated many times before, will be more accurate and effective than most forms of market analysis, as I have shown in this chapter so far.

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