Monday, October 27, 2014

SPX Update, and a Few Notes about Elliott Wave

Before we look at the charts, I'd like to talk a little bit about using Elliott Wave in trading.  There are some key points that new traders sometimes miss -- but I've been employing Elliott Wave for so long that, at times, I forget that fact.

As I see it, there are three main values to Elliott Wave:

1.  It allows us to identify inflection points in advance.
2.  It often allows us to identify trend changes -- sometimes even before the trend actually breaks.
3.  It allows us to find high-probability targets, including unconventional ones.

Let me draw a recent example, using the "three main values" outlined above: 

Months ago, Elliott Wave allowed me to identify the (then pending) inflection point near 1920 SPX (value #1).  We reached that inflection point, and the market reversed.  The impulsive decline from the high then allowed me to confirm that the trend was changing before the trend lines broke, and that the inflection point had likely generated a meaningful reversal (value #2).  I then used various formulas to arrive at a downside target of 1824-1833 SPX (value #3), which was subsequently captured.  I further used Elliott Wave to identify that the downside target represented another inflection point, one which could mark the bottom of a C-wave, thus ending the decline (value #1 again).

The trouble I see traders getting into, over and over again, is by not acknowledging that there are limitations to any and every system, including Elliott Wave.  Limitations must be respected.  One does not make money by pursuing fantasies, but by negotiating reality.

The fantasy is that we can somehow know every single move the market will make in advance.  The reality is that we cannot.

If we pursue the fantasy, then we'll take too many high-risk entries, we'll watch winning trades turn into losers, we'll hold on to losing trades for too long, and we'll just generally manage our risk poorly.  Once we accept reality, then we can trade accordingly -- which equates to trading more effectively and more profitably. 

So, let's also discuss a recent example of the limitations, and how those limitations must be acknowledged and respected:  When SPX bottomed at 1820, I immediately began mentioning that a potential ABC corrective decline could have completed in its entirety (an ABC would mean that new highs were on deck).  In the very first update I published after 1820 was hit, I wrote:

"At this point, wave (4) and (5) are suggested by the momentum, but not guaranteed by the pattern, as the very first five-wave decline after a bull market simply cannot be anticipated.  The preferred count got us to the 1824-33 target, after hitting the turn off the ATH perfectly.  Now it's time for at least some degree of humility."

I published no new official downside targets, but I did discuss how a fourth and fifth wave might develop.  Obviously, what I do as a trader is not the same as what I do as an analyst.  The primary difference between the two is that, while every move can be analyzed to some degree, not every move can or should be traded aggressively.  In other words, as an analyst, my job is to tell you what I'm seeing (or not seeing).  As a trader, my job is to make money (i.e.- protect and grow my capital).  And that means recognizing when a move is probable vs. when a move is speculative, and trading and protecting myself accordingly.

An example of a probable move is a wave that's expected to be wave C or 3 -- that's a "confirmed" impulsive trend wave, which is expected to follow the impulsive wave A or 1.  That type of move might be traded aggressively.

However, after that's complete, then we encounter limitations: Trading waves 4 and 5 of a move that is labeled C/3 should be considered speculative, since the very existence of the "C" label means that waves 4 and 5 are unknown variables. 

I'll come back to all this in another update in the near future, because I haven't shared nearly all my thoughts here yet.  But for now, I'll just leave you with one final thought to consider (which I'll also get back to in more detail in the future):  Not every good trade is profitable, and not every profitable trade is good.

Last update, I discussed that the market appeared to suggest that at least a minor top was near.  I published a downside target, and while we did get another small wave down as I anticipated, it failed the expectations of a standard c-wave, and fell a couple points shy of my first target.

As outlined Friday, the bigger picture signals still suggest a downward turn is near, though the degree of said turn is presently unknown.  In that regard, there's little to add to Friday's update, so please refer back to it if you missed it.

Shortly after Friday's close, I published the following 1-minute chart in my forum, and based on the futures action this morning, it appears this near-term count from Friday was/is correct.  The minimum downside expectation for this pattern would (normally) be 1946 +/-. 

A deeper retrace than 1946 seems more probable, but -- talk about front running! -- we basically ended Friday at the highs, so there's literally nothing in the way of a turn or downward wave structure to draw from yet.

In conclusion, the market is still within a turn zone, however, the degree of said turn is currently unknown.  I should be able to draw more conclusive targets as the wave structure develops.  Trade safe.

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