Saturday, April 21, 2012

Elliott Wave / Trading Strategy 101

Elliott Wave - Trading Strategy

This feature will simplify and explain the difference between discretionary vs. non-discretionary trading strategies and how they work in confluence with Elliott Wave Theory specifically, and alongside technical analysis in general.

In a few minutes, we will be applying this tutorial to a Mid-Level trading account, which carries a medium-term timeframe exposure to Netflix (NFLX).

Before we begin, we must first give kudos to our friend and associate Greg Simmons at Scope Labs for influencing our development and implementation of the non-discretionary trading strategies deployed in our Chart Cast Pilot service.

We developed and coded the non-discretionary strategy rules into our automated trading platform based upon algorithmic confirmations of Elliott Wave trends and terminals from minor to primary degree. Think, (HFT) or “high-frequency-trading” in slow motion.

Despite some roughness around the edges and in-your-face banter along with scaring many folks out of their wits not to mention the markets, we really like “G” primarily because he knows his stuff, and secondly because he cusses a lot, gets mad, and as such, he’s entertaining as well as informative, and we know he’s the real deal.

To get a small glimpse into his mindset relative to trading, check out his latest, and in our opinion, his most effective technical presentation that we have seen regarding his views on the real risk in shorting the 10-year.

Like many of us, despite the widespread aversion toward exposure to the financial sphere, he too is engaged in the markets, and in a far more complicated manner than most people can wrap their heads around.

For the purpose of our simple tutorial, we will again lead with another of Greg’s recent videos entitled: Risk – How 90% of People Lose Money Trading.

We do so for a couple of reasons. First, among many of the elements of wisdom shared in the video, we agree with Greg’s definition of what distinguishes the difference between a discretionary and non-discretionary trader/investor. Secondly, in minor contrast, we also wish to disagree in one sense, relative to the 90% of losers.

Yes, 90% of traders may be losers on a given day/week/month however, the next day/week/month, a percentage of those included in the 10% winners circle the period prior, will inevitably find their way to losses of their own. The point of correction or subtle clarification here is NET winners and NET losers over an extended period of time.

Even the best non-discretionary trading strategies endure periods of drawdown and losses. Insofar as discretionary trading/investing, we fully agree with Greg, full time discretionary traders/investors are nothing more than ticking time bombs waiting to explode right alongside the passive do-nothing buy & hold forever paralytics.

The bottom line in our view is that no one, no strategy, no how, can engage the market in any timeframe for an extended period of time without enduring losses along the path toward being part of the 10% of NET winners. This is the simple point we wanted to drive home that we are sure Greg agrees with, but simply forgot to convey in the otherwise excellent video below. Enjoy.

Okay, now that you’re all pumped full of wisdom and insight, let’s get on with our feature.

Mid-Level Trading Accounts                 Netflix                 SYMBOL: NFLX

Daily Chart of Netflix

Before we distinguish some of the differences between making trading decisions using one’s discretion vs. a proven strategic methodology, we will first take you through where Mid-Level Accounts have been with regard to past exposure in Netflix.

By now, everyone knows that Netflix crashed in a rather hard and fast landing from well over $300 dollars per share all the way down beneath $65 dollars in 2011.

Long before it became clear that something was going terribly wrong with the one-way parabolic upward move in the stock price, (no, not APPLE, Netflix) our wave counts were already anticipating that a long-term cyclical high was getting ready to crest.

At what specific price and exactly when this would occur, we did not know, but we did know that when the tide did turn, it could indeed get very ugly. (Though the two are entirely different companies, consider this feature a pre-warning for Apple Investors)

So how do you position and prepare for the unknowable? With a quantified mechanical strategy, that is how.

The takeaway here is that you cannot guess at a top regardless of whether or not specific price targets or ratios printed, nor which wave counts you may have rendered complete.

Well, you can guess, and that’s okay, it’s just that you can’t make a strategy out of such an exercise no matter how much excitement or potential profits it would bring if you happened to eventually guess right.

Such an approach is simply ignorant and one that will consistently beat your account down to zero barring a few lucky guesses here and there. Worse than trying too hard to nail tops and bottoms, is remaining totally passive and complacent in “buy & hold” mode. This too is a rather moronic investment strategy.

So, what did we do in Mid-Level trading accounts as Netflix began to unravel? We held onto longs (rather profitably, I might add) despite the substantial drawdown from peak equity while NetFlix skated on thin ice above $300, and we began our downward bearish wave counts.

Yep, that’s exactly right, we stayed long for a stretch while our preferred Elliott Wave counts had already begun the doomsday countdown.

You must understand, that you cannot be 100% sure that your analysis is bulletproof, especially at the very start of a major trend change. You must wait for some form of confirmation that is aligned with your timeframe and objectives prior to hitting the “take profits and reverse short” button.

This chart does not show our short entry, but it does illustrate precisely when and where we took 61.87% in downside profits and reversed back the long side of the ledger, and it was nowhere near the 62.37 print low.

In fact, it was January 10 of this year at a price of $99.80. So why didn’t we get long at the primary “A” wave bottom at 74.25? After all, if we had a primary degree bottom in place basis our wave count, there would be no place else for price to go but up, right? WRONG!

If it were even possible to have bought the precise 74.25 low, one would have had to endure a false start to the upside followed by a negative drawdown in excess of -15% as the stock price hit fresh new lows at 62.37, in what in our view, is an expanded –b- wave at minor degree.

So, despite our flawless trend lines, price targets, and Elliott Wave labels, all of which we consider essential to gaining visual perspective on market structure, we held onto shorts until it was much clearer that the 62.37 level would most likely hold for taking a reasonably decent stab at the long side in medium-term trading accounts.

Now keep in mind that between back-to-back enormous profits on both the upside and downside, that at this point, though we got another winner, one simply cannot expect a third consecutive trade to perform anywhere near as well.

In fact, what one should expect after back-to-back Grand Slams is a bout of whipsaw trades, which render a series of relatively small losses, and that is pretty much what we got, and where we stand today.

After two back-to-back Grand Slams, our long trade from 99.80 racked up another 7.21% in profits just for good measure.

Then in March and April, we got the inevitable “whipsaws” in which we lost two trades in a row, giving back around 13%, and our trading strategy is now short from 107.32.  All told, we are still way ahead of the game by light-years in these trading accounts.

So, how does our current strategy position align with our current wave count dynamics?

Let’s fast forward and take another look at the current chart of Netflix as we wrap up this feature.

Daily Chart of Netflix

If this prospective wave-count turns out correct in its assumption that 62.37 is indeed an expanded –b- wave at minor degree, then it would not be out of the realm of probability to anticipate the move up from this low to contain five waves of upward advance.

Such a move would most likely be the start of a wide-ranging breadth in price action of substantial duration leading toward its ultimate primary degree “B” wave end.

Right now, the wave count is at a crossroads whereby the current short-term downtrend may be working off a bullish 4th wave decline at minute degree, which if correct, would then suggest another leg up to end wave-5 of –c- of (a), and yes, eventually of “B”.

So why didn’t the strategy stay long for a 5th wave up to the minor –c- of intermediate (a)? Because there is enough algorithmic evidence present in the price action that warrants caution that the intermediate (a) wave may already be in place at the 133.43 print high.

That is not to say with certainty that short side caution will turn out to be correct however, based upon the internal algorithms, no matter how slightly, the odds today favor positions to the short side.

In short, that is why you cannot use the discretionary interpretation of Elliott Wave structures no matter how good they might be, to methodically trade from, especially over an extended period of time.

Yes, you may be right more often than trading on 100% pure random emotion, but overtime, you will fare no better than an even coin-toss, and only if you are extremely lucky at that.

In closing, we will leave you with the actual commentary for this chart as it appeared in the Chart Cast Pilot.

As referenced above, the trading strategy remains bearish NETFLIX in Mid-Level trading accounts.

(NMC) Excellent example of the practical application of Elliott Wave Theory: Outside the purview of the trading strategy, we have noted 77.59 as an area of (KO) or Key Overlap from an Elliott Wave perspective.

To get five clear waves of upward advance from the 62.37 low, we need to see a high north of 133.43 prior to a move beneath the 77.59 level. As an aside, we identified 120.28 well in advance as an overhead level of resistance at the 4th wave of one lesser degree.

As illustrated by the ALT: (a) wave designation in the powder blue label atop the 133.43 print high, a breach of the 77.59 (KO) level as described above will add a higher level of probability that the ALT: (a) wave designation is the correct one.


How do you ride a bear market

Yes, it is that simple!

Until Next Time,