The Magic of The Elliott Wave Principle

Note: This article was originally published on 20 March 2009 on Wavetimes Blog and is linked to my book “Five Waves to Financial Freedom.”

So you have come here looking for the elusive magic of The Elliott Wave Principle in the forex market! Robert Balan, an old friend, once said, "Can anyone parlay a $10,000 capital into $1,000,000 in a year? In five years? If so, how do you do it, and what risks are involved?"

I have been practising Elliott Wave Analysis for over 35 years and have made some astounding calls that came true. But I cannot honestly say I could turn a mere $10,000 into a million dollars. Yet, I can confidently say that there are very few technical approaches to dealing with the uncertainties of the marketplace as efficiently as the Elliott Wave Principle.

I will not give you the rules and guidelines governing the practice of Elliot Wave Theory. There are ample resources on the web that you can access at the click of your mouse. What I will do, instead, is to give you one example now and show you the working of the magic of the Elliott Wave Principle in the Forex market.

Let us suppose that we are now in the early 1990s and have already seen the first big move from 1.0520 to 2.0045 (Point A). When the second attempt failed to sustain above that level, we should have anticipated a swift move down. Remember that the third step of any progression is always a decisive move. We could have easily calculated that a 61.8% Fibonacci retracement of the Wave "A" would lie at 1.4158. The move actually finished at 1.4063.

Next, consider the "c" wave that went from 1.7366 to 1.3677. Believe it or not, that move was just 7 pips short of the 61.8% measure of the "a" wave. But the Elliott Wave magic doesn't stop there. Wave "B", which went from 1.3677 to 2.1161, was only two pips short of 78.6% of wave "A". The Elliot Wave Principle asks us to always be on the lookout for Fibonacci relationships between alternating waves.

Now, let us turn to the daily chart. This is a lot more interesting. As you can see from the comments on the chart, one could have placed a low-risk "buy" trade near 1.7450 as it marked a 161.8% projection of the first wave down. One of the problems that many beginning-analysts face is how to pick a level and call it the end of a certain wave? For example, how did I label the 1.7450 level as a mini wave 3?

With hindsight, it all looks so good, but how on earth can one figure out that we will not break down directly? (See for example how the 261.8% level at 1.5628 did not hold). Welcome to the real world of Elliott Waves! The key to lasting success in the business of trading is to be honest with your paradigm. Follow your rules (whatever they may be) to the letter. The biggest sin that a trader can commit (second only to not having a stop loss) is to keep changing his rules.

Take a look at the chart again. When you get a fast sell-off, you should calculate various projections and keep them by your desk. I would have known that 1.7450 was likely (but not certain) support. I would not have bought there the first time. Typically, in a fast-moving market, we will always get a retest of the lows.

If the market stabilized near a Fibonacci projection at the first try, I would place a small 'buy' order near the prior low with a stop just a few pips below that low. As you can see, we got a second test of 1.7450 two or three days after the first try. Since the buying interest was strong at that level, the trade paid off handsomely. (Another tip: When doing Elliott Wave analysis, I recommend you depend on daily charts more than hourly charts to figure out supports and resistances).

Let us look to the future now. Why do I think we could go higher to around 1.6170? First, you should understand that to make money, it is not as important to know the medium-term targets as it is to know the general direction! What if we don't get as far as 1.6170? Most traders would be just as happy to catch a move to 1.4900! Anyway, back to the question.

We saw that Wave (2) at 2.097 was a 'simple' correction. This means there is a high probability that Wave (4) will be a complex one. We have already seen that the "B" wave (as I labeled it) is an irregular correction, with the low coming well below the end of Wave (3).

If you accept this count as valid (and remain truthful to that count until proven wrong), then you should look for the Wave "C" within the Wave (4) to go well above the top of the wave "A." Besides, the second test of the low seen AFTER posting the "B" wave bottom could not break the prior low.

Finally, we not only saw a strong move higher, but it has managed to break above a declining (green-colored) downtrend line. These are just some reasons I am looking for Sterling to continue moving higher.

If one only worries about being 'correct' in making market calls, one will never be a good trader.

Below, I am producing some additional charts of GBP to show you how things turned out. As you will observe, the Sterling Pound did rally quite nicely.

Final Thoughts

It is vitally important to have an open mind about these things. Consider this. I have a market reputation and will look silly if the Pound stops climbing and goes down directly. Should I allow that to bother me? If one only worries about being 'correct' in making market calls, one will never be a good trader.

A trader must study his charts and make the most educated prediction about what will happen next. He should then execute his plan of action without wavering one bit. This includes having an affordable stop-loss and plans to take profits along the way. There is no other way to riches. One must combine wave analysis with money management to benefit from the magic of the Elliott Wave Principle in the forex market.

This article was initially published in their April 2009 issue in FX Trader Magazine.

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