Trend
Waves
The cult of Elliott Wave Theory intimidates
the most experienced traders. But don’t let wave voodoo stop you from adding
important elements to your chart analysis. Sharp uptrends routinely print orderly
action-reaction waves. EWT correctly recognizes these predictive patterns through their
count of 5 primary waves and 3 countertrend ones.
Wave impulses correspond with the crowd's emotional
participation. A surging 1st wave represents the fresh enthusiasm of an initial
breakout. The new crowd then hesitates and prices drop into a countertrend 2nd impulse.
This coils the action for the sudden eruption of a runaway 3rd wave. Then after another
pullback, the manic crowd exhausts itself in a final 5th wave blowoff.
Traders can capitalize on trend waves with very little
knowledge of the underlying theory. Just look for the 5-wave trend structure in all time
frames. Locate smaller waves embedded in larger ones and place trades at points where two
or more time frames intersect. These cross-verification zones capture major trend,
reversal and breakout points.
For example, the 3rd wave of a primary trend often
exhibits dynamic vertical motion. This single thrust may hide a complex 5-wave rally of
the next smaller time frame. With this knowledge execute your position at the 3rd of
a 3rd, one of the most powerful price movements within an entire up trend. While
waves may appear difficult to locate, the trained eye can uncover these price patterns in
many strong up trends.
Many 3rd waves trigger broad continuation gaps. These
occur just as emotion replaces reason and frustrate many good traders. Since common sense
dictates the stock should retrace, many exit positions on the bar just prior to the big
gap. Use timely wave analysis (and a strong stomach) to anticipate this big move just
before it occurs.
4th wave corrections set the sentiment mechanics for the
final 5th wave. The crowd experiences its first emotional setback as this countertrend
generates fear through a sharp downturn or long sideways move. The same momentum signals
that carry traders into positions now roll over and turn against them.
As they prepare to exit, the trend suddenly reawakens and
price again surges. During this final 5th wave, the crowd loses good judgement.
Both parabolic moves and aborted rallies occur here with great frequency. Survival of the
last sharp countertrend adds an unhealthy sense of invulnerability into the crowd
mechanics. Movement becomes unpredictable and just as the last greedy participant places a
bet, the uptrend ends unexpectedly.
