There’s one wave in the Elliott wave sequence that you as a forex trader don't want to miss: the third wave. Like the Energizer Bunny, third waves "just keep going and going." Riding them can be very rewarding -- but pity you if you happen to get caught on the wrong side of one without an exit strategy.
Third waves, says Prechter & Frost's classic Elliott Wave Principle – Key To Market Behavior*, are "wonders to behold. They are strong and broad, [they] generate the greatest volume and price movement, and are most often the extended wave in a series."
Sounds good, but how do you trade them? Well, first, you have to identify a third wave developing. Let's say you've counted waves 1 and 2 on a chart, and you're willing to bet your money that wave 3 is next. Of course, you don't know for sure if it is or not, so to protect yourself, you recall one of the three rules of Elliott: "Wave 2 cannot retrace past the origin of wave 1."
You could then place your stop-loss just below the starting point of wave 1. If your ostensible wave 2 goes past the origin of wave 1, you'll know that it was not a 1-2 with a 3rd wave in the making, after all.
We've recently witnessed a real-life third wave in the U.S. Dollar Index, which measures the strength of the dollar against a basket of six foreign currencies. Here is an intraday chart EWI's intensive Currency Specialty Service published on the morning of December 22:
You can see how the action in the USDX from the December 3 low clearly fits a third-wave profile. Of course, after a 3rd wave come waves 4 and 5, so a correction could be due soon. When? In the words of EWI's Senior Currency Strategist Jim Martens, "we will continue to favor the dollar until chart developments suggested otherwise." Stay tuned to the latest updates with Jim's Currency Specialty Service*.
*You get a free copy of Elliott Wave Principle – Key To Market Behavior with your subscription.