How to Spot Trading Opportunities

Discover a whole new way to analyze charts and spot high-confidence trade setups using technical analysis in this eBook through clear, concise explanation from Senior Analyst Jeffrey Kennedy.

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  • How the simplest rules and guidelines have some of the most powerful applications for trading
  • How to apply a unique Fibonacci technique to help you evaluate risk and reward
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  • How to determine when to act decisively when market action demands it vs. when to sit on the sidelines


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How to Spot Trading Opportunities Using the Wave Principle -- Part 1

By Jeffrey Kennedy, Editor of Trader's Classroom,

Elliott Wave International's educational subscription service.

Chapter 1 — Basics of the Wave Principle
We provide you with an Introduction to the basic idea of the Wave Principle and details about wave patterns in bull and bear markets.

Chapter 2 -- More Information About Corrective Waves
We give you more details about corrective waves, which are the starting points for spotting high-probability trading opportunities.

Chapter 3 -- How the Alternation Guideline Works in Corrective Waves
We explain how patterns of corrective waves alternate, which helps to pin down a trading opportunity.

Chapter 4 -- How To Spot High-Probability Trading Opportunities
We put together all of the information about the Wave Principle and use it to spot trading opportunities.

Chapter 5 -- Questions and Answers
We answer selected questions from participants of the How To Spot Trading Opportunities webinar.

Introduction

Welcome to this Elliott Wave International course, "How to Spot Trading Opportunities Using the Wave Principle." My name is Jeffrey Kennedy, and I am the editor of Elliott Wave International's newest service, Trader's Classroom, an educational subscription service that helps you learn to spot trading opportunities in any market.

I've broken this course into four sections: (1) the basics of the Wave Principle, (2) more specifics about corrective waves, (3) the guideline of alternation within corrective waves, and (4) spotting high-probability objectives in commodities trades.

Editor's note: This webinar was originally presented live on April 21, 2005.


Chapter 1 -- Basics of the Wave Principle

HTS-Part-1--Figure-3

Figure 3

Let's begin with a quick overview of the Wave Principle. To some of you, this will be old hat, while others may find this information new and exciting. The Wave Principle is a form of technical analysis based on crowd psychology and pattern recognition that Ralph Nelson Elliott originated in the late 1930s. He discovered that stock market prices trend and reverse in recognizable patterns and that these patterns form larger and smaller versions of themselves – something that we now call fractals. He went on to codify his discovery by identifying 13 such patterns and providing rules and guidelines for the Wave Principle's practical application. Figure 3 is the basic pattern or building block of the Wave Principle.

To apply the Wave Principle correctly, you must follow its three cardinal rules put forth by R.N. Elliott:

1. Wave 2 cannot retrace more than 100 percent of wave 1.
2. Of waves 1, 3 and 5, wave 3 can never be the shortest.
3. Wave 4 can never end in the price territory of wave 1.

If you stick to these three primary rules, you will stay out of a lot of trouble and be able to apply the Wave Principle correctly.

HTS-Part-1--Figure-5

Figure 5

The move identified as wave (1) in Figure 5 is called an impulse or motive wave; it subdivides into five waves, labeled waves 1, 2, 3, 4 and 5. Five-wave moves are important according to the Wave Principle, because they define the larger trend. Once a five-wave move is complete, a three-wave decline follows it, labeled A-B-C. This three-wave move is called a correction and represents a countertrend move. Whenever this sequence is complete, it will repeat -- that is, it will be followed by another five-wave move and three-wave correction, ad infinitum.

All Elliott wave patterns originate from this ever-repeating sequence of five waves and three waves, which we refer to as fives and threes. And as R. N. Elliott observed, these patterns form larger and smaller versions of themselves, thus making the Wave Principle fractal in nature.

The idealized chart shown in Figure 5 could be a two-minute price chart of the S&P, or it could be a weekly chart of the Dow Jones or T-bonds -- it does not matter. What is important is that you notice this up-down sequence consists of a five-wave move followed by a three-wave decline. And if you look closely, you'll see that within these advances and declines, they subdivide even further into smaller five-wave advances and three-wave declines.

Now, I am not a photographer, but I have heard the phrase "the money shot" before. When it comes to the Wave Principle, Figure 6 is the money shot because it identifies which waves within the cornerstone Elliott wave pattern offer trading opportunities.

HTS-Part-1--Figure-6

Figure 6

On the left-hand side of this illustration, there are two bullish trade setups. As traders, we want to wait for the wave (2) correction to be complete so we can catch the move up in wave (3) -- this is the trade. What we are trying to do in this bullish trade setup is anticipate the potential for profits on the buy-side as prices move up in wave (3). Another bullish trade setup is at the end of wave (4).

As traders, we are looking to buy the pullback and position ourselves within the direction of the larger up-trend. Remember, three-wave moves are corrections, which means that they are countertrend structures. On the other hand, five-wave moves define the larger trend. As traders, we want to determine what the trend is and trade in the direction of the trend. Our buying opportunity to rejoin the trend is whenever the trend pauses and forms a correction.

Now, let's look at the right-hand side of the illustration where we see two bearish setups. When a five-wave move is complete, it is retraced in three waves as a correction. The end of the five-wave move presents the first trading opportunity that we can take advantage of the short side (or the sell side) as the wave (A) down begins. Notice the second bearish trade setup gives us another shorting opportunity as wave (B) tops.

So, within the classic wave pattern of five waves up and three waves down, we have four high-probability trading opportunities in which we are either positioning ourselves in the direction of the trend or identifying termination points of a trend.

These are the four types of trade setups I like to focus on as a trader and as an Elliottician. And let me add one more bullish trade setup: Whenever we have a three-wave move complete to the downside (for example, the circled wave 2 in Figure 6), I look to buy the pullback. Why? The larger five-wave move preceding it determines that the trend is up, which has been confirmed by the downside move unfolding in only three waves. So, at this point, after seeing a five-wave advance followed by a three-wave decline, I am again looking to buy, because another five-wave move to the upside is about to begin.

I think that Figure 6 is one of the more important money shots in this course, so I will review it again later to familiarize you with the different trading opportunities the Wave Principle offers.

HTS-Part-1--Figure-7

Figure 7

Before we go much further, I want to quickly review the basic wave patterns. Figure 7 shows pictures of how an impulse wave, a zigzag, a flat, a triangle, and a corrective combination appear in both bull and bear markets.

Now, let's talk about each wave pattern in detail. Figure 8 is a classic example of an impulse wave.

HTS-Part-1--Figure-8

Figure 8

Do you remember the three cardinal rules of the Wave Principle? One of the rules is that wave 2 cannot fall below the origin of wave 1. Another cardinal rule is that wave 3 cannot be the shortest impulse wave of waves 1, 3 and 5. The final cardinal rule is that wave 4 cannot end in the price territory of wave 1. And as you can see, in this example, each of these rules adheres. While this is a very simplistic example of an impulse wave, remember that impulse waves are important because they identify the direction of the larger degree trend.

Figure 9 shows a five-wave decline, and, as I previously stated, five-wave moves determine the direction of the larger trend. So, in this example, we know the larger trend is down.

HTS-Part-1--Figure-9

Figure 9

Now, we're going to look at all the corrective patterns. I highly recommend that you spend some time studying these corrective wave patterns because these moves introduce trading opportunities. As a trader, it's very important to define your trading style. My trading style is to buy pullbacks in up trends and to sell bounces in downtrends. Because this is my trading style, I spend a lot of time studying corrective wave patterns. As we review the following Elliott wave corrective patterns, I will show you some easy tricks that will help you identify a correction and its termination point.

HTS-Part-1--Figure-10

Figure 10

Figure 10 illustrates what Elliotticians call a zigzag pattern. This zigzag subdivides into 5-3-5, which is Elliott Wave shorthand for the number of subdivisions within each wave. As you can see, the first wave clearly subdivides into five waves. Wave B, a corrective wave within the correction, subdivides into three smaller waves. And wave C subdivides into five waves. That's why this pattern is some- times referred to as a 5-3-5 pattern. And since this pattern is comprised of only three waves, which means it's a correction, we know the larger trend is up, making it a bull-market zigzag.

HTS-Part-1--Figure-11

Figure 11

Figure 11 is simply the previous pattern in- verted, making it a bear-market zigzag. So, when this pattern is complete, you will see a sell-off on your price charts. Moreover, it implies that the larger trend is down.

HTS-Part-1--Figure-12

Figure 12

Figure 12 is a flat correction, and it differs from the zigzag in that, instead of subdividing into five waves, the first wave (wave A) subdivides into only three. Another characteristic of the flat correction is that wave B terminates at or near the origin of wave A. On your price charts, it is a wave pattern that is fairly easy to spot; it is the only wave pattern that allows for wave A to be a three-wave move and for wave B to be a three-wave move back to near the origin of wave A.

HTS-Part-1--Figure-13

Figure 13

Figure 13 is a flat correction in a bear market. It is simply the inverted picture of the previous chart. When this correction is complete, prices will turn to the downside.

HTS-Part-1--Figure-14

Figure 14

The next corrective pattern we will look at is the contracting triangle (Figure 14). A triangle is a tricky pattern that can waste a lot of a trader’s time and emotional capital because it is basically a sloppy sideways move. A contracting triangle is a sideways price movement that subdivides into five waves – waves A, B, C, D and E. Notice that each wave subdivides into three smaller waves. Wave A is a three-wave move, wave B is a three- wave move, and so on. One good thing about a contracting triangle, though, is that it occurs only in the wave 4, B or X positions. It also resolves in a push to the upside in what Elliotticians refer to as a thrust.

HTS-Part-1--Figure-15

Figure 15

Figure 15 is a contracting triangle in a bear market or in a bearish wave position, meaning it will thrust to the downside when it resolves.

HTS-Part-1--Figure-16

Figure 16

The last corrective pattern is called a corrective combination (Figure 16). In some cases, it is referred to as a double-three and is labeled as W-X-Y. This wave pattern is also easy to identify, because it typically forms as sloppy sideways price action, consisting of seven distinct waves.

HTS-Part-1--Figure-17

Figure 17

Figure 17 illustrates a rare triple-three correction. Even though this wave pattern is rare, you still should be familiar with its formation in case you see one.

Chapter 1 Key Points

HTS-Part-1--Figure-18

Figure 18

Although it's good to recognize these different wave patterns, Figure 18 is the one figure I recommend you remember, which I am repeating from earlier in this course book. It clearly spells out the highest probability trading opportunities the Wave Principle offers.


Chapter 2 -- More Information About Corrective Waves

I want to share with you some tricks I have picked up over the years about how to analyze corrective waves and their termination points. The single most important thing I’ve learned from analyzing corrections is that corrective or countertrend price action is usually contained by parallel lines.

HTS-Part-1--Figure-20

Figure 20

As shown in Figure 20, draw the parallel lines, by beginning at the origin of wave A and going to the extreme of wave B. You draw a parallel of that line off the extreme of wave A. So basically you have is small, slightly angled downward price channel. This will show you the containment region for wave C. It also shows you an area toward the bottom of the lower trend line where you can expect a reversal in price.

HTS-Part-1--Figure-21

Figure 21

Here is another example in Figure 21. Again, you draw the parallel lines off the origin of wave A, the extreme of wave A and the extreme of wave B. Toward the upper end of the upper trend line, you will usually see a reversal in price.

HTS-Part-1--Figure-23

Figure 23

Figure 23 shows how countertrend price action is contained by parallel lines in the British pound, 60-minute, all sessions. Why is it important to know parallel lines contain the corrective or countertrend price action? Number one, it will increase your confidence that you are indeed labeling a countertrend move properly. Number two, it identifies areas where you will likely see prices reverse. For example, we see this reversal up near the top. This is two simple trend lines, and we can catch the reversal.

HTS-Part-1--Figure-24

Figure 24

Figure 24 shows simply an A-B-C decline. Prices reverse near the lower end within the lower boundary line of our price channel.

HTS-Part-1--Figure-25

Figure 25

Here is a corrective wave structure that I have gone ahead and labeled A, B and C. As you can see in Figure 25, the whole pattern is contained by parallel lines; more importantly, wave B itself is contained by parallel lines. I use this simple but useful technique regularly. If you are familiar with Daily Commodity Junctures, and to a lesser extent, Monthly Commodity Junctures, I highlight this technique often.

HTS-Part-1--Figure-26

Figure 26

This example shows why I also draw midlines between the parallel lines of corrective wave structures. Often you will see reversals either at the lower or upper end of the lines of your corrected price channel. You can also see reversals at the center line or midline.

HTS-Part-1--Figure-27

Figure 27

You can see how significant the center line becomes as this corrective move up develops in Figure 27. The structure overall is a good example of what a corrective structure looks like. Corrective structures contain numerous overlapping waves -- they're choppy, and they're sloppy. An impulsive move should look like the incline at the left of the chart -- straight up, simple to identify, very clean, clear and crisp. In impulse waves, prices travel the farthest in the shortest amount of time. In contrast, the correction is a very slow and choppy move up here. Our parallel lines help us identify this move as a corrective wave pattern. If we were trading the move, we would see a center-line reversal and a possible short-side trade.

HTS-Part-1--Figure-28

Figure 28

I have only one rule for the techniques I use or develop in my analysis. They must work consistently, in any market and on any time frame. As you can see in this weekly chart (Figure 28), we have the reversal at the center line and go from $14 up to $26. Corrective price action usually stays within parallel lines. It is a simple but powerful technique, because you can identify countertrend price action within a larger upturning market. It actually identifies specific regions where you should expect reversals.

HTS-Part-1--Figure-29

Figure 29

Here is a two-minute S&P chart. I have gone ahead and labeled this chart according to our standard Elliott wave labeling. As you can see, we have waves 1, 2, 3, 4, and 5 in blue. The subdivisions are all clear within each of the waves.

HTS-Part-1--Figure-30

Figure 30

Now, I'm going to throw in some Fibonacci ratios that Elliotticians use to measure retracements. Notice wave 4 ends slightly above the .618 retracement of wave 3. It is a little deep for a fourth wave but acceptable.

HTS-Part-1--Figure-31

Figure 31

This line I've drawn in the lower right-hand corner of the chart shows that wave 5 settles just below a nice Fibonacci relationship with waves 1 through 3. As you can see in the equation, wave 5 equals a .618 multiple of waves 1 through 3 at 1209.96, which is what price action comes to and reverses.

HTS-Part-1--Figure-32

Figure 32

I wanted to show you this chart because it shows that both fourth-wave moves were indeed contained by parallel lines. Let's go back and look at the previous chart.

HTS-Part-1-Figure-32a

Figure 31

In Figure 31, you can see both wave iv and the larger 4 were enclosed by parallel lines. Remember, this is a two- minute price chart where the technique works. Earlier, we were looking at a weekly stock chart where this technique worked equally well. So, I hope I have shown that using parallel lines to delineate a corrective wave pattern has value. I use it, and I recommend that you use it, too.

HTS-Part-1--Figure-33

Figure 33

How do you use the corrective price channel technique when you have a flat or an expanded flat correction? First, look at Figure 33 to see what an expanded flat correction looks like on a price chart.

HTS-Part-1--Figure-34

Figure 34

Remember, with flat corrections, wave 1 subdivides into three waves. You can see in Figure 34 that the first sell-off subdivides into three waves followed by another three-wave move. This particular pattern is considered an expanded flat correction instead of a regular flat correction because wave B moderately exceeds the origin of wave A.

HTS-Part-1--Figure-35

Figure 35

How do you draw corrective price channels when you have this type of structure? First, look at the Elliott sub-divisions of this corrective pattern in Figure 35. As you can see again, wave A subdivides into three waves, wave B subdivides into three waves (making a moderate new high), and there is a reversal after five waves in wave C.

HTS-Part-1--Figure-36

Figure 36

You can draw the parallel lines two different ways. In the first case, as shown in Figure 36, you can draw them against the extreme of wave ii.

HTS-Part-1--Figure-37

Figure 37

Or, as shown in Figure 37, you can draw the parallel line against the extreme of wave iv.

In the examples I showed you previously, you took a line from the origin of wave A against the extreme of wave B. With this second technique for a flat or expanded flat correction, you simply take the trend line from the origin of wave A against the extreme of wave ii or against the extreme of wave iv. Notice again the same tendency: prices reverse near the lower boundary line of our corrective price channel.

HTS-Part-1--Figure-38

Figure 38

Here is another example of a flat correction, this one for a stock at the 60-minute price level. Pick out the origin of wave A and the extreme of wave iv. We have our parallel lines drawn and notice that prices hit the lower boundary line and reverse nicely. Here prices go from about 32 up to 35, and I think they actually went on much higher.

HTS-Part-1--Figure-39

Figure 39

Let me reaffirm that these trade setups coming off of corrective wave patterns are the ones that I focus on as a trader and as an Elliottician. And going back to our original "money shot" chart, you can see that each one of these trade setups positions you in the direction of the larger trend. They allow you to have the wind at your back as you follow the trend either up or down, which is why I like these trade setups.


Chapter 3 -- How the Alternation Guideline Works in Corrective Waves

In this next section, we discuss the guideline of alternation, which says that corrections alternate their wave patterns. For instance, if wave 2 is a sharp correction like a zigzag, wave 4 will often be a sideways affair like a flat, expanded flat or a contracting triangle. Typically, when Elliotticians refer to alternation, they focus on waves 4 and 2.

HTS-Part-1--Figure-41

Figure 41

Over the years, I have also noticed alternation usually occurs from one corrective wave to the next and also within corrective waves. Let me show you what I mean in Figure 41. Look at the structure in the middle of the chart encompassing the two price gaps.

HTS-Part-1--Figure-42

Figure 42

Here, I marked in red the three-wave move. We have a move up, a move down and another move up. This is clearly a corrective move. What I am referring to when I speak about alternation within corrective waves is what you see here: that wave A appears as a single line while wave C clearly subdivides. If, on the other hand, wave A subdivided into five waves, wave C would probably be a nearly straight line.

HTS-Part-1--Figure-43

Figure 43

I have attached wave labels, and you can see we have a decisive move up in wave A, followed by wave B. Wave C then clearly subdivides into five waves. This is a lovely example of alternation within the structure of waves A and C. Overall, I find the alternation guideline reliable and consistent.

HTS-Part-1--Figure-44

Figure 44

Look at this corrective structure when it is contained by parallel lines, as in Figure 44. There is a basic reversal at or near the center line or midline of the price channel in wave C.

HTS-Part-1--Figure-45

Figure 45

Let's look at another chart to see how alternation works within a corrective wave pattern.

HTS-Part-1--Figure-46

Figure 46

In Figure 46, wave A is the sloppy wave this time, while wave A contains numerous overlapping waves. I’ve picked a fairly extreme example, which subdivides into nine waves, so it is an acceptable impulse wave. (This is a deeper theoretical conversation than I want to get into.) My point is that wave C is a straight-line affair, and wave A has the multiple subdivisions. In the previous example, wave A was the straight-line affair, and wave C contained multiple subdivisions.

HTS-Part-1--Figure-47

Figure 47

When the corrective move is contained by parallel lines, we can see that it reverses near the upper boundary line of our corrective price channel.

HTS-Part-1--Figure-48

Figure 48

This final picture of the same chart on a larger timeframe shows that the structure we were looking at was wave B within a contracting triangle. This resolves very nicely, by the way, into a final upward thrust.

HTS-Part-1--Figure-49

Figure 49

In this example, wave A is a seemingly straight-line affair. Granted, there are subdivisions, but wave A does not have the clear subdivisions that wave C does.

HTS-Part-1--Figure-50

Figure 50

A reminder: As a corrective or countertrend move, it will most likely be contained by parallel lines.

HTS-Part-1--Figure-51

Figure 51

Next up is an interesting picture of one of our combination patterns. Notice the X at the top in the middle of the chart. This is an ABC-X-ABC or a double-3. You will notice that even within this structure, the same principle of alternation within corrective waves applies. Wave A in the first half is a seemingly single-line affair, and wave C clearly subdivides into five waves. On the second portion of our double zigzag or double correction, wave A is the wave that has the multiple subdivisions, while wave C is a single-line affair.

HTS-Part-1--Figure-52

Figure 52

In Figure 52, you can see the double zigzag as a corrective wave pattern more clearly. It is contained by parallel lines and terminates at or near the lower boundary line of our corrective price channel.

HTS-Part-1--Figure-53

Figure 53

As the commodity guy at Elliott Wave International, I typically look at Feeder Cattle, a lot of meat, the softs, Coffee, Corn, and Soybeans, but I also look at many other markets. Here is another three-wave structure on a 60-minute price chart for Google.

HTS-Part-1--Figure-54

Figure 54

The same alternation guideline applies whether the chart shows an equity or a commodity; we have an alternation between waves C and A.

HTS-Part-1--Figure-55

Figure 55

Here is the Elliott wave count, showing the subdivisions within the structure.

HTS-Part-1--Figure-56

Figure 56

Here is the same chart showing the corrective price action usually contained by parallel lines. Also, notice the reversal at the centerline.

HTS-Part-1--Figure-57

Figure 57

Here is a daily price chart of Ultra Petroleum. This is a good example of a sharp sell-off in wave A, followed by a clear five-wave subdivision within wave C. The subsequent rally from $37.50 went up to a little bit more than $50.

Chapter 3 Key Points

HTS-Part-1--Figure-58

Figure 58

We have learned three techniques so far:

1. Corrections are our opportunity to position ourselves in the direction of the larger trend. We know that as Wave Principle practitioners, we want to buy at wave 2 pullbacks, we want to buy at wave 4 pullbacks, and we want to sell at the top of wave 5 (if we are lucky enough to do that) or B-wave bounces.

2. We have learned that corrective price action tends to be contained by parallel lines. The parallel lines help us more confidently identify countertrend moves within larger trending markets. Moreover, parallel lines also identify points of termination.

3. The guideline of alternation allows us to better determine the timing of the end of these corrective patterns because we will be able to decide whether the pattern will be a straight-line affair or a sub-divided one that takes longer to play out.


Chapter 4 -- How To Spot High Probability Trading Opportunities in Commodities

In this last section, we will focus on spotting high-probability objectives for trades.

HTS-Part-1--Figure-60

Figure 60

I will be specifically referring to the multiples of 1.382 and 2.0, which are numbers within the Fibonacci sequence because they are crucial to a technique I call "reverse Fibonacci." With reverse Fibonacci, I measure the length of the previous wave, multiply that by 1.382 or 2.0 and project up- ward, which gives me a specific price level.

Why are these levels high-probability price targets? Even those who are not familiar with the Wave Principle know that whenever you are trying to project or forecast extremes in impulse waves -- for example the top of a third wave -- typically, you use a Fibonacci 1.618 multiple of wave 1. That is, use an impulse wave to measure another impulse wave. Also, within corrective wave patterns, use the length of wave A to project the length of wave C.

The technique of reverse Fibonacci is a little different from these Fibonacci projections that identify terminat- ing points or targets. As a trader, I am not necessarily looking to sell top-tick or bottom top-tick. Instead, I am looking for a high-probability objective I can safely count on or bank on. So I want to identify a corrective pullback, initiate a position and, ideally, at the same time give the broker my exit price, too.

How did I come up with these 1.382 and 2.0 numbers? I spent about six months doing an exhaustive study on how far moves that make new price extremes continue, so I came up with these "reverse Fibonacci"relationships. I discovered that about 90 percent of the time, prices attain a 1.382 multiple of the previous swing, and about 70 percent of the time, prices will attain a 2.0 multiple.

Notice on Figure 60 that prices exceed the 2.0 level on this chart. Remember, I am not looking to make top-tick; as a trader, I am looking to attain a high probability objective, make a profit and live to trade another day. You will also notice that prices exceed the 1.382 level moderately; still, this is a profitable position, and it gives me a high probability objective to shoot for.

Let's take a look at some examples that I had fun putting together. I just may convince you of how useful reverse Fibonacci can be.

HTS-Part-1--Figure-61

Figure 61

The first example is taken from Treasury bonds on the weekly level. To project where a correction may lead, I simply multiply the first move down on the left (marked with a black line) by 2.0. That gives me a projection, which I have marked with a red line. On this chart, prices push moderately above 2.0 and then reverse in a sharp, tradeable reversal. Now we go back to the previous swing up to the 2.0 target (marked by a black line) and multiply that by 1.382, which gives us another target to shoot for.

In this example, we miss the move down at the first 1.382 by just a tick or two; but still, it is a high-probability objective. Over to the right of the chart, there is a 2.0 multiple of the previous swing and a 1.382 multiple of the previous swing. Again, I have to remind you that these levels will be exceeded either moderately or sometimes substantially. But my style of trading is to get in, make my money and get out. I am not looking to get 100 percent of the trend. As a trader, I want to capture 80 percent of the trend. I found that these numbers, these relationships and this reverse Fibonacci application worked out well for me, which is why I am sharing them with you.

HTS-Part-1--Figure-62

Figure 62

This Figure 62 is an exciting chart. It's a weekly chart for crude oil. Our swing is down on the left, marked by a black line. Then we have our 2.0 multiple of that swing: we nick it, one goes above it, and then we see a very nice sell-off of almost $15. You can use this technique as a guideline for locating possible reversals in price action, rather than for exit points or objectives for positions.

HTS-Part-1--Figure-63

Figure 63

This 20-minute price chart of the S&P in Figure 63 represents more than five days’ worth of price action. I want to walk you through swing by swing and show you the validity of the technique.

HTS-Part-1--Figure-64

Figure 64

Focusing on the left-hand side of the chart and now on a 10-minute time frame, I have taken this first swing, marked in black, and multiplied it both by 1.382 and 2.0. My target is that third blue line down. As you see, we hit it, exceed it moderately and prices reverse.

HTS-Part-1--Figure-65

Figure 65

Then I take this small swing marked in black in Figure 65 and multiply it by 1.382 and 2.0. Again, we achieve both levels, exceed them moderately and prices reverse.

0909-HTS-Part-1--Figure-66

Figure 66

Now we focus on the next swing marked in black, and we attain our 1.382, exceed it a little bit and reverse nicely in this three-wave structure.

HTS-Part-1--Figure-67

Figure 67

Here is a small swing down. As you can see, we attain the 1.382 multiple of the previous swing, we exceed it moderately and prices reverse.

HTS-Part-1--Figure-68

Figure 68

Here is a three-wave move up marked in black. Again we go to 1.382, hit the objective and prices reverse.

You can use these techniques by themselves. However, I’ve been using Elliott wave analysis for 13 years, and I am now more of a believer in the Wave Principle than I ever have been. This S&P chart we are analyzing is just the best example of why I like to combine these proven techniques with the Wave Principle. For instance, notice this move we have just marked in black is a clear three-wave structure to the upside. It is a three-wave countertrend move, so I know the larger trend is still down. Although these techniques work by themselves, I think they are much more powerful when used with the Wave Principle because it is the best tool for defining the proper context of price action.

HTS-Part-1--Figure-69

Figure 69

These 1.382 and 2.0 multiples are excellent exit points, objectives and areas to look for potential reversals. I am still working with that basic S&P 20-minute chart I showed as the first chart in this series (Figure 63), while walking you through on the 10-minute price level. This is intra-day or day trading on this level, and you can see how effective the approach is.

HTS-Part-1--Figure-70

Figure 70

Now in Figure 70, we finally come to an example in this series where we do not attain the 1.382 multiple. This is a very important lesson. Nothing works 100 percent of the time. The best we can hope for is maybe 90 to 95 per- cent. Even if you had a technique that worked 99 percent of the time, the X variable is still out there, which stands for the unknown. Sometimes things simply do not work. You may be holding 4 aces but it still can be beaten by a royal flush.

HTS-Part-1--Figure-71

Figure 71

Our 1.382 multiple was not hit, so let's look at the smaller subdivisions. Here we attain the 2.0 multiple of the previous swing.

HTS-Part-1--Figure-72

Figure 72

Here we attain the 2.0 multiple of the previous swing.

HTS-Part-1--Figure-73

Figure 73

Here we attain the 1.382 multiple of the previous swing. So even though we are not able to attain the 1.382 multiple of the previous swing of the larger move, there are many sub-moves we are still able to identify with, such as strong potential turning points, exit points or reversal points.

HTS-Part-1--Figure-74

Figure 74

Moving forward in time on this S&P chart, here is a nice objective that is easily attained by the S&P.

HTS-Part-1--Figure-75

Figure 75

In addition to looking for just the big swing here, I decided to walk it through smaller swings. Notice I am taking the previous swing and multiplying it by 1.382 or 2.0 for a high- probability objective. As you can see, prices attain the objective and then turn down; they do so in three waves. Remember, three-wave moves are countertrend and tend to be contained by parallel lines.

HTS-Part-1--Figure-76

Figure 76

It moves to 1.382, we come down and touch it and prices reverse.

HTS-Part-1--Figure-77

Figure 77

We hit it here at 1.382…

HTS-Part-1--Figure-78

Figure 78

…and again here at 2.0.

HTS-Part-1--Figure-79

Figure 79

Here is another example of the same technique.

HTS-Part-1--Figure-80

Figure 80

Here, I am looking at only two variables, 1.382 and 2.0.

HTS-Part-1--Figure-81

Figure 81

Here is a really nice example where we attain a 1.382 multiple, exceed it moderately and then prices reverse.

HTS-Part-1--Figure-84

Figure 84

I like this chart in Figure 84 the best. With the technique of determining high-probability objectives, we used only two multiples, 1.382 and 2.0, and every calculation I showed you for the last 10 charts is attained. We identified 18 potential targets, and we achieved 18 specific targets.

Notice many of these objectives are simply reversals. We hit them and reverse. That is one way you can use the technique or you can simply use them as profit-taking objectives.

Chapter 4 Key Points

I am not much of a dancer; I don't know how to waltz or tango, but my mom did teach me the box step. It is basically 1, 2, 3, 4; 1, 2, 3, 4. In this course, I have taught you the box step.

Step 1: You learned the basics of the Wave Principle, and more importantly, you learned specifically what trading opportunities the Wave Principle offers.
Step 2: You learned corrective price action usually stays within parallel lines or corrective price channels. That is important because we also know that the corrections usually end at either the center line of the corrective price channel or the upper or lower boundary of the price channel.
Step 3: You learned about alternation within corrective waves. Why is that important? It allows you to time the end of countertrend moves more accurately.
Step 4: You learned how to spot high-probability price objectives. Once you are in the trade, you know where to get out, with a high degree of certainty that you will be able to walk out with a little bit of money in your pocket.

Summary

In this course, I tried to give you some real-world tools that work in a real-world environment. I know trading is difficult, especially futures and commodity trading, and I hope I have accomplished my goal of giving you some valuable pointers on working with corrections and reverse Fibonacci.


Chapter 5 -- Questions and Answers

Q: Could you give us tricks as to how to initiate a position or how to know when to position at the middle line of the corrective trend channel or the extreme line?

Kennedy: If you're seeing a reversal near the lower boundary line and you know that the larger trend is up, a break of the center line is a very simple way to enter a position. If you're seeing prices reverse from the center line, the break of the upper or lower boundary line is probably a trigger to go long or short.

Q: Exactly what are you multiplying by 1.382 or 2.0?

Kennedy: What I'm multiplying is the previous move. So I'm essentially multiplying the previous swing by 1.382 or 2.0 and that gives me my high-probability objective.

Q: On the flat correction, is wave C always a five-wave correction?

Kennedy: Yes, wave C is always a five-wave move. Okay, there's an exception -- wave C within contracting triangles subdivides into three waves. I think that's the only exception I can recall right now. A good rule of thumb, though, is that wave C is always five waves. Stick with it.

Q: If wave A of a zigzag is a five-wave move, and wave 1 of an impulse is a five-wave move, how can you tell the difference?

Kennedy: That is a very good question, and I've got a very good answer for you. Tentatively label all five-wave moves wave A of a correction. I do that because I've found it keeps me from getting my hopes up unwisely before I know whether the wave pattern is an impulse or a correction.

Let's just say we have a five-wave move to the upside, and I label that wave as wave 1. Then the pullback I'm looking for would be a wave 2 and that would be followed by a third-wave rally. So I've got big expectations for wave 3. What I've found is that this approach often biases me whenever I'm in that third-wave time frame.

Instead, I like to label almost every five-wave move as a wave A. Then as prices unfold in wave B, I can then expect a wave C to develop. Since the most common relationship between wave C and wave A is equality, I'm going into that next impulse wave with minimum expectations. If I'm rewarded, and it's a third-wave rally, I'm that much happier. But if my expectations are only set for the minimum outcome, I'm not disappointed, and I still recognize a C wave. So I would recommend that you be prudent in your labeling. Until the price action can confirm your wave count, begin with labeling it a wave A.

It's much like one of the biggest mistakes I made as a trader: I always had my expectations set too high. I was always looking to make a home run on a trade I would initiate. So since I was always looking for the home run, every time I hit a single or a double or a triple, it wasn't good enough. In doing so, I left a lot of money on the table many times. So what I do right now is I'll hit the ball, maybe look to get on base. If it's anything beyond that, then that's gravy.

Meet Your Author


Jeffrey Kennedy

Jeffrey Kennedy Chief Commodity Analyst

Jeffrey Kennedy, MSTA, CFTe, CMT, CEWA-M, is Chief Commodity Analyst at Elliott Wave International (EWI), with 25-plus years of experience as an analyst, trader and teacher. He writes Commodity Junctures, EWI's premier commodity forecasting package that focuses on Elliott wave analysis of the commodity markets. He also produces Trader's Classroom, an educational service that shows how to spot trading opportunities with wave analysis and supporting technical methods. In 2014, he achieved the title of a Chartered Market Technician, certifying his proficiency in multiple technical analysis tools. Subscribers and students always tell us how committed he is to empowering them to achieve trading success.

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