My my old friends and mentors Bill Williams and his daughter Justine, themselves both successful traders and accomplished Ellioticians, I have always respected the prominent five wave count that makes up the basics of R.N. Elliott's Wave Theory. What had always held me back from fully embracing Elliot Wave however was that it was just too subjective and no one could ever really say where it stopped and started, or so it seemed to me. I gravitated to Dow Theory and eventually my own Risk Tolerance Threshold Theory, which is based on a tenet of Dow Theory, because it was completely mechanical - no subjectivity: the collective pattern is either bullish or bearish so we are either buying dips in an uptrend or selling rallies in a downtrend; RTT Theory even provides specific buy or sell zone based on a simple retracement pattern. Elliot Wave on the other hand is a study where the more of Elliot's rules we try to apply, the more the market would confound us by breaking them. The one thing I did learn from that tendency though was rules governing pattern and direction have to be loose and time based - it is not nearly as important if price trades below a particular level as it is if price closes below that level.
Over this past summer a new student in London started Skyping me about how accurate the price levels he was getting from using the RTT method were. While RTT Theory was new to him, he had over 7 years trading experience. While it was not unusual for a student to let me know how things were going with their studies on a week to week basis, the frequency of his messages stood out -- he was telling me about winning trades every day. When we got together for a one on one session he told me with great excitement that what he had learned from RTT Theory was the last piece of the puzzle for him. What stood out to me was that while yes he did have an advantage because he was trading London hours, the market environment we were in could have been better - many of the major markets were counter-trending with longer-term patterns counter to shorter-term patterns. In other words he was beating our benchmark method - something I have had trouble doing consistently -- and he was doing it in counter-trending markets!
Of course I was happy that he had found the last piece of the puzzle, and asked him about the other pieces. He quickly explained that he had been following a day trading method that was based on taking trades after 3 impulsive waves had played out. Right away I said "Elliot Wave", and he agreed but said technically it's not Elliot because he had learned to not consider all the different measurements and retracements of classic Elliot Wave, but to just watch for the 3 impulse waves. We both agreed on the validity of that; I teach that when it comes to hard and fast rules in measuring patterns less is more. He went on to say that it was the mechanical bias, and fractal based framework of support and resistance levels provided by RTT Theory that gave him the confidence to take advantage of the wave patterns. The 5 wave Elliot patterns - #1 impulse, followed by #2 reactive, followed by #3 impulse, followed by #4 reactive, and concluding with #5 impulse - which themselves are fractal in nature, often start and end in RTT zones - levels based on Dow Theory which mark pattern reversals. See Figure 1. He also knew to look for shorter-term wave cycles, often in the same session, and rarely spanning more than 1 full day. I understood the importance of this from my own studies of patterns and cycles - their continuity breaks down quickly from one session to the next, or as quickly as it takes new information to enter the market. If there is a news release with information counter to the previous wave cycle or pattern and price produces a sizable move, do not expect the previous intraday cycle to hold. It is this tendency which has frustrated Ellioticians who made the mistake of thinking market wave counts are predetermined - they are not!
The experience has been very exciting for me because it improves on an excellent trend trading methodology and now opens the door to counter-trend opportunities which is something I have always shied away from. Once the full 5 wave pattern plays out in the direction of the overall trend it becomes much more likely price will retrace a predictable percentage of that move, particularly if the current price range created by the trend move is well beyond that markets average range.
If like me, you had dismissed Elliot Wave Theory in the past because it was too subjective, or just didn't hold up over the long-term, you may want to revisit it on the intraday charts, particularly when using the fractal based mechanical framework introduced by Risk Tolerance Threshold Theory.
Jay Norris is the author of "The Secret to Trading: Risk Tolerance Threshold Theory". To see Jay highlight trade set-ups and signal in live markets for free go to: Live Market Analysis
Trading is a risky endeavor and is not suitable for all investors!