Swing Trading Strategies & Stock Picks Since 2003

Before I begin this discussion, I am in no way putting down anyone who uses Elliot Wave Theory as a technical benchmark with which to trade. Anyone who has read Jack Schwager's Market Wizards and New Market Wizards knows that there are at least 38 (in fact, there are infinite numbers) ways to trade markets profitably. I am simply presenting the methodology that I use and the evidence that validates it.

I was asked a great question in StockTwits Saturday by @splumlee3 with regard to point measurement for Fibonacci patterns ( like the XABCD patterns that I find ).

His question was "Do you think the origin of price to arrive at pt X in the patterns you look for is important?"

The answer is YES and it speaks directly to the difference between looking for Fibonacci trading patterns and using traditional Elliot Wave Theory for trade entries and exits. I know there are tons of Ellioticians out there and again, I want to make certain that you understand that I will never diss an Elliotician. My big problem with Elliot Wave Theory, however, is that much of the interpretation of it is very subjective. What I am about to demonstrate is that the X point of measurement in XABCD patterns are discreet and can often be verified by momentum analysis if there is any question as to the origin of point X. The X to A leg of the pattern is the leg against which all pattern movements are measured against. That quality is what makes it tradable and makes the risk of each trade measurable and discreet.

The X point is defined as the nearest momentum low (in a bullish pattern set up) and a momentum high (in a bearish pattern set up).

For the bullish set up, lets look at $MCF again (since we have used that example a million times and is familiar to the 20 readers who read this blog frequently). Take a look at this chart and notice the red X and the black X. The red X is the bearish X because it represented the most recent momentum HIGH. The black X is the bullish X because it is represented by the most recent momentum LOW.

Let us now look at the implications of those selections in pattern analysis.

The Bearish Pattern:

The XABCD Bearish pattern started on January 6, 2009 and ended June 1, 2009. Though A-B did not completely equal C-D (price symmetry is not perfect, the retracement pattern is uniform and momentum did reverse there (I will get into the implications of that in another blog post).

But you may ask me "You presented this as a LONG trade? Why are you showing me a short trade when you were pushing it as a long trade?" Good question. Here is the answer.

The Bullish Pattern:

The XABCD Bullish pattern is shown here. Again, XABCD is defined by the momentum LOW at X. Though the A-B segment is not equal to the C-D segment. the retracement levels are very close those that the nets like (and the nets DID like them, which is why I traded that set up).

The Implications of Choosing and Measuring against the X to A Leg:

As you can see, I traded a very nice long trade in the context of a much longer BEARISH trading pattern. I provided all of the fundamental reasons in the multipost series regarding the MCF trade. The technical reasons have been demonstrated by looking for momentum highs and lows. This is far more specific than using stochastics (because as you have seen from my previous posts I actually can find the price BAR for which the reversal hits), and is much more specific than moving averages, because moving averages LAG horribly. When the X ot A leg has been defined, all retracements from that leg are definable and completely measurable. Elliot Wave analysis, in all its sophistication, cannot really do that.

What I am about to say here would likely make Larry Pesavento step back a bit, perhaps in disapproval, but thorugh my years of studying these patterns (if you recall from my discussion of neural net analysis), the most important element in these patterns are the momentum reversals at those D bars and the retracement levels from X to D.

Your assignment for now will be to take a ruler and draw lines to the left and right of the B points in these patterns, and I will demonstrate for you that asymmetry between A-B and C-D is acceptable as long as the retracement levels fit within that 0.618,0.707, 0.786, or even 0.841 or 0.886 area. What you find when you draw that horizontal line at B is the reason I consider the ruler THE most important technical analysis tool man has ever invented.

Look at the air traffic control Fibonacci screen for MCF (these are the Pesavento Pattern functions provided with the Ensign software). See the 0.707 retracements. They are both legitimate pattern ending retracements that are NOT 0.618 retracements. That is why I use neural nets to define pattern completions in terms of historical context. If I showed you a longer term string of data for MCF, you would see this pattern repeat. Remember, I want repitition with some form of statistical certainty before I pull the trigger. That is why I use computers and neural net software to give me that edge. If I turned down every trade that was NOT a perfect 0.618 retracement, I would be leaving money on the table. The pattern is still legitimate, even if the symmetry is not perfect.

I could probably write a book about price symmetry in real market context, but it would put you (and probably even me) asleep by the time I finished it. Take this as a first lesson and start to identify these patterns in the charts you trade. Remember what I said about drawing horizontal lines at B. Once you do that (and in fact do that with X A B C and D points), you will begin to have a real world ability to FORECAST TURNING POINTS. That is what this methodology is all about.

More on that later. I have pressing business to keep up with, there will be more and hopefully more timely content coming. Stay tuned.