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Jay Norris
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Jay Norris is a 20-year CBOT floor veteran, author of the Best Seller "The Secret to Trading Forex, Futures, and ETFs: Risk Tolerance Threshold Theory", "Mastering the Currency Market", McGraw-Hill, 2009, and "Mastering Trade Selection and Management", McGraw-Hill,... More
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The Secret to Trading Forex, Futures, and ETF's: Risk Tolerance Threshold
  • Utilizing Elliott Wave In Today's Markets 0 comments
    Oct 13, 2013 11:23 AM

    I was first introduced to trading on the floor of the Chicago Board of Trade in the early 1980's. I first read the Elliott Wave Principle in early 1988 after Robert Prechter gained some acclaim for having called the stock market crash in October of 1987. I also remember the trader Paul Tudor Jones put a lot stock in Prechter's work and of course the original analysis of R.N. Elliott.

    Initially there was such a gulf between how I saw how markets moved and who moved them versus Prechter's interpretation of Elliott's work that I put the theory on the back burner. In trying to apply it myself over time I often found no continuity from one week to the next, and even more concerning was the attachment that came from developing an opinion based on the analysis. That's a handicap. "Lose your opinion, not your money" has always been gospel to floor traders. Luckily I never fully dismissed the advantage that 5 wave pattern can lend a trader.

    The one thing the trading floor teaches you is that every day is a new day. In other words "time" must be incorporated into your analysis or trading method. In addition every time important news hits the market there's the possibility that the market is going to reset itself, or start over. When that happens there is a change in how professionals and market makers were operating before and after that event, therefore they'll be a disconnect in the shorter-term cycles, or even the longer-term patterns depending on the actual news versus expectations. When that happens, the influence of the pattern on the next higher time-frame or in Elliott parlance "the next higher degree" becomes negligible. Experienced traders get that, and analysts looking for the continuity of a cycle need to accommodate that also. Sometimes that disconnect is as simple as the markets close on Fridays, traders' attention gets redirected while considering the coming week's events, and the market reopens and resets on Sunday. Or on an intraday basis it can be as quick and simple as in-house market makers change shifts between the Tokyo session and the London session. Professionals are good at seeing that, but the chart won't show it unless you already know what to look for. In my initial study of Prechter's interpretation of Elliott Wave (E.W.) it lacked a time element which I saw as crucial. Rather than continue to study E.W. I chose Dow Theory, and took a tenet of that study and combined it with my knowledge of risk tolerance and came up with Risk Tolerance Threshold Theory which became the premise of the method I follow.

    While a lot of traders I know had dismissed Elliot in favor of more mechanical approaches don't think professionals don't know about that 5 wave cycle where the market rotates from impulsive behavior to reactive behavior and back to impulsive behavior. That's real, but it is less academic then most books on trading would have us believe. My old friends Bill and Justine Williams, both accomplished traders also consider themselves Elliotticians. Luckily because of the Williams' success I realized I could not dismiss Elliott Wave, and did cover it in my first book with McGraw-Hill, Mastering the Currency Market, 2009. What brought my attention back to E.W. was when a new student of Risk Tolerance Threshold Theory told me of his success in using our collective patterns and levels to frame 5 wave patterns --with no regard to a wave count. And he was beating our benchmarks!

    I could see right away that by applying the RTT framework and levels and approaching the 5 wave pattern from an odds-makers standpoint, instead of a speculator trying to predict the next outcome, the wave cycle is an excellent tool / filter. While markets will show predictable retracement patterns, how often do they show repetitive cycles with the level of geometric precision illustrated in Elliott Wave books? Enough to bet our hard earned money on? Not enough in my experience. However when you consider the possibility that the market is more likely to produce a reversal following a five wave pattern than after a 2, 3, or 4 wave pattern, than you have a potential edge because the one thing most analysts are good at is seeing those 5 waves. Add in that every correction according to Elliot Wave ends in a "C" wave which itself is a 5 wave pattern, and you have a good reason to consider E.W., particularly on the intraday charts. In our experience when we see a market complete a 5 wave pattern into significant structure - support or resistance - regardless of the wave formation prior to that, we look for a potential reset and reversal -- Figure 1. Regardless of what experienced Elliott analysts tell us the proper wave count is or should be, if we use basic money management we should stay out of trouble and by default catch the impulse moves when a larger wave pattern kicks off.

    (click to enlarge)
    Figure 1. USDJPY resets following completion of 5 wave pattern on 50% level on Friday 10-11-13

    Figure 2. USDJPY Short-term Risk Tolerance Threshold Ratio for 10-11-13

    Under the circumstances in Figure 1, most E.W. analysts will try to fit in how to categorize those 5 waves in the big picture so they can predict what will happen next. A trader on the other hand should wait for support to hold -- in this case the buy zone created by the 50% and 618% levels -- then wait for a signal, take a long position, and use sound money management, particularly when we see the majority of short-term patterns are higher on our RTT Ratio - see Figure 2. When you consider Elliot Wave Theory as a tool, or a component in your trading plan to help you shrink your losing percentage, instead of a standalone method, you free yourself from the analysis paralysis which inflicts so many E.W. students. And when you use it on the lower time frames - the graph in Figure 1 is a 3-minute chart - you avoid that cycle disconnect caused by new incoming information and or the daily and weekly closes. In the chart in Figure 1 prices shifted higher following a less than expected drop in U.S. consumer confidence at 9:00 AM despite an ongoing government shutdown. As traders we need to know that we are not here to count and categorize waves looking for the perfect trade; we are here to risk our money to make more money. It is still trading and the key to utilizing EW to your advantage is going to be understanding risk. Man and the markets he created are far from perfect. You are not going to be right all the time. Unless you accept the reality of loss you are setting yourself up for perma-demo status. It is far more important to make money than it is for your wave count to be in agreement with online EW analysts in the blogosphere.

    Jay Norris is the author of "The Secret to Trading: Risk Tolerance Threshold Theory". To see Jay highlight trade set-ups and signals in live markets for free go to: Live Market Analysis

    Trading involves risk of loss and is not suitable for all investors

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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