# How to Trade Elliott Wave

Looking at all of the glossy ads promoting analysis software, educational courses, seminars, workshops, newsletters, past gurus, new gurus, astrologers etc. you could be forgiven for thinking that taking profits out of markets is simply about something called 'forecasting'

All you need to do, apparently, is pay your money and you too can forecast with such amazing accuracy that you'll be able to trade on the hoof for just an hour a day as you travel from beach resort to each resort. Yes, it's really you on the lounger by the pool in that promo!

Strangely enough, trading is not like that. Professional traders have nothing but disdain for the hype and misinformation peddled largely by those catering to the masses of private traders. 'Professional' doesn't mean 'permanently making money', by the way. It has a lot more to do with the crucial elements of trading often never even mentioned in the ads and promos. 'Professional' is more an alternative for 'controlling risk'.

Elliott wave can actually help (unbelievably)

There are two aspects to the practical meaning of risk if you're actually trading: probability risk (the risk of an unanticipated outcome for a trade) and money risk (the amount of money lost if a trade doesn't turn out as expected). The first is typically the most difficult of the two to pin down. Everyone accepts that trading with the trend is essential to make money, so in Elliott Wave (EW) terms this could mean aiming to trade off the end of a correction-to-a-trend and back into the trend itself. This can be in one of three places: off the end of a wave 2 into a trend wave 3, off the end of a wave 4 into a trend wave 5 and off the end of a wave B into a trend wave C.

If you can find any of these three places on a chart, you are starting to address probability risk. The ideal would be a correction which unfolds in the simplest possible manner - as an ABC, zig-zag or 3-wave - the easiest-to-identify correction in the arcane and complex world of Elliott. The probability of this set-up working is enhanced if it's completely clear, follows an unambiguous trend and the its wave C is at a critical price level. That price level can be provided consistently by using the well-known Fibonacci ratios comparing one price move with another eg. where there is a cluster of ratios relating wave C to both wave A and wave B.

This is geared to assessing where, say, buying pressure is becoming exhausted in a correction up against a previous established downtrend. Probability risk could be further improved by requiring the market to give a sign that it's preparing to move in your direction - before jumping headfirst into a trade. The traditional reversal bars or Japanese candlestick reversal patterns or extreme oscillator reversals can do this job.

It's easy to get distracted by win/loss stats

This doesn't necessarily mean that if you can achieve all this, you'll have a [[win/loss ratio]] up near 100%! Most 'professional' traders with a strong performance record actually work on a win/loss below 50%. They've learnt to be comfortable with that, because they understand what novice traders often don't.

Money risk is the next key. Understanding this risk is to understand not only how much is at risk before a trade is placed but also that your money risk is being kept below a certain proportion of your account. A trader needs to know the entry price and initial protective stop price in advance. Clearly, the closer the entry to the stop the smaller the money risk per share/future/forex lot etc. The advantage of a structure such as the ABC correction as described above is that the initial stop can always be the extreme price reached in the ABC correction eg. the wave C end. This is where your trade analysis would be proved wrong.

Similarly, the entry price can always be at the extreme of your signal bar, whether a textbook reversal bar, a Japanese doji candlestick or whatever. This is far more difficult to do at other points in any EW sequence, assuming you somehow know where you are in the pattern!

Then it's a simple matter of dividing that money risk into your maximum money risk per whole trade - say, 2% of a \$20,000 account or \$400. Your position is now sized.

Risk/reward and profitability

Now it is simply a numbers game and one that novices often lose by excessive emphasis on the win/loss statistic. Winning 70% of your trades is no use if you only win \$400 on each winner but lose \$1000 on each loser. In practice, most profitable professionals have a win/loss ratio below 50% (sometimes well below) but control of risk and concentration on risk versus reward enables them to limit the losses against the wins. Result - profits.

Elliott wave has to be stripped, though

As Elliott theory all too often seems the preserve of academics, a stark approach is needed. The standard pitfalls of EW have to be avoided, otherwise you have little chance of success. An 'isolation approach' sidesteps the need to fit a current pattern into a previous pattern or into a larger timeframe (or several - there are 9 different Elliott frames cited by Frost & Prechter in their seminal 'Elliott Wave Principle'). There's no need to desperately squeeze a smaller pattern out of your current pattern on-screen or to struggle with dreaded 'alternate counts'.

This also means no interference mid-trade, avoiding the dangers of EW counts changing when you're in an open position - such uncertainty is completely unwelcome!

All in all, controlling risk rather than obsessing about accuracy, you have a chance of at least buying a sun lounger like the one in the ad!

Tony Beckwith is Director of Sales & Marketing for the
MTPredictor
product range. He has a number of years of both bank and private trading experience.

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