I continue my conversations with Jeffrey Kennedy, editor of Elliott Wave International's Futures Junctures Service, where subscribers get news of daily and longer-term opportunities in commodities.
Vadim Pokhlebkin: Jeffrey, let's talk about situations when an Elliott wave forecast doesn't come true. I've just read today's issue of your Daily Futures Junctures (Dec. 08; online now. – Ed.), and I think it's a good example for us to look at. But before we do, can you tell me, in your estimate, how often a forecast doesn't work out as planned?
Jeffrey Kennedy: It depends on your definition of a "good forecast." If you called the market's direction correctly, but the price stopped short of your target, is it a good forecast? Some would say yes; others may disagree. But let's just say that the market throws you a curveball often enough to always be on guard. Elliott wave analysis is not foolproof – I don't know of any forecasting method that is – but new Elliott wave users often forget about that. Fortunately, the Principle has "built-in" safeguards against failed forecasts.
VP: You mean, the Three Rules of Elliott?
JK: Exactly. They can do an excellent job to help you protect your capital in case your forecast doesn't come true. The rules are simple:
- Wave two can never retrace more than 100% of wave one.
- Wave three can never be the shortest impulse wave of waves one, three and five.
- Wave four may never end within the price territory of wave one.
You mentioned tonight's Daily Futures Junctures (Dec. 08; online now. – Ed.) – it shows a great example of how critical these rules can be for risk management. Cocoa futures have been rallying since mid-November, as you may know. He market reached a peak of 2308 in late November and sold off – in what looked like the first and second waves of an unfolding 1-2-3-4-5 impulsive decline. That meant that the trend had turned down. But then today, Cocoa rallied and printed a slight new high above that 2308 peak. That negated my previous "one-two" labeling immediately. You understand why?
VP: Because you assumed that 2308 was the start of wave one down. So, if you apply the First Rule of Elliott, the wave two rally could not move above 2308 – that would mean it retraced more than 100% of wave one, a rule violation.
JK: Exactly. So, if you were expecting Cocoa to sold off under that count, your risk would be clearly defined by the 2308 price point. When the market moved above it today, I knew instantly and without a doubt that the old wave count had to go. That's why I'm offering a new wave scenario for Cocoa in tonight's Daily Futures Junctures. (Dec. 08; online now. – Ed.)
VP: How strict are these rules?
JK: They are called "rules" for a reason. Every time you disregard one, you are greatly jeopardizing your entire wave count and possibly your entire position.
VP: Thank you for another informative conversation, Jeffrey.
JK: My pleasure!