Visual Guide to Elliott Wave Trading

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Visual Guide to Elliott Wave Trading by Wayne Gorman and Jeffrey Kennedy

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Visual Guide to

Elliott Wave Trading

Wayne Gorman

Jeffrey Kennedy

Foreword by Robert R. Prechter, Jr.

Cover design: C. Wallace.

Cover images: Waves by Peter Firus/iStockphoto, charts courtesy Wayne Gorman and Jeffrey Kennedy.

Copyright © 2013 by Elliott Wave International, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Gorman, Wayne.

Visual guide to Elliott Wave trading / Wayne Gorman, Jeffrey Kennedy ; foreword by Robert R. Prechter, Jr.

     pages cm.—(The Bloomberg financial series)

 Includes index.

  ISBN 978-1-118-44560-0 (paperback); ISBN 978-1-118-47953-7 (ebk);

  ISBN 978-1-118-47950-6 (ebk); ISBN 978-1-118-47954-4 (ebk); ISBN 978-1-118-47951-3 (ebk);

  ISBN 978-1-118-75405-4 (ebk); ISBN 978-1-118-75416-0 (ebk)

  1. Speculation.  2. Stocks.  3. Elliott wave principle.  I. Kennedy, Jeffrey (Business writer)  II. Title.

 HG6041.G593  2013

 332.64’5—dc23

2013005664

Contents

How to Use This Book

Foreword

Acknowledgments

Introduction

Disclaimer

Part I: Trade Setups

Chapter 1: The Anatomy of Elliott Wave Trading

Jeffrey Kennedy

Part II: Trading Examples

Chapter 2: How Zigzags and Flats Set Up a Trade for the

Next Impulse Wave

Jeffrey Kennedy on CAT, TECH, and the Australian dollar

Wayne Gorman on silver and robusta coffee

Chapter 3: How a Triangle Positions You for the Next Move

Jeffrey Kennedy on GCA

Wayne Gorman on DELL

Chapter 4: Riding Wave C in a Zigzag

Wayne Gorman on S&P futures and T-bond futures

Chapter 5: Using Ending Diagonals to Trade Swift and Sharp Reversals

Jeffrey Kennedy on DJIA, BSFT, SLW, and TCK

Wayne Gorman on the euro

Part III: Going Beyond Elliott Wave Patterns

Chapter 6: Applying Technical Indicators

Jeffrey Kennedy on CREE, WMT, and WYNN

Chapter 7: A Basic Options Trade

Wayne Gorman on the euro

Chapter 8: More Advanced Options Trades

Wayne Gorman on heating oil and soybeans

Chapter 9: Parting Thoughts

Appendix A: Introduction to the Wave Principle, by Wayne Gorman

Appendix B: Bloomberg Functionality Cheat Sheet

Glossary of Elliott Wave Terms

Educational Resources

About the Authors

Index

How to Use This Book

The Visual Guide to… series is designed to be a comprehensive and easy-to-follow guide on today’s most relevant finance and investing topics. All charts are in full color and presented in a large format to make them easy to read and use. We’ve also included the following elements to reinforce key information and processes:

Definitions:Terminology and technical concepts that arise in the discussion

Key Points: Critical ideas and takeaways from the full text

Bloomberg Functionality Cheat Sheet: For Bloomberg terminal users, a back-of-the-book summary of relevant functions for the topics and tools discussed

Go Beyond Print

Every Visual Guide is also available as an e-book, which includes the following features:

Video Tutorials: To show concepts in action

Test Yourself: Multiple-choice or true/false quizzes to reinforce your newfound knowledge and skills

Pop-Ups: Definitions for key terms

Foreword

For many years, I have wanted to have my company produce a trading book based on the Elliott wave model. As with markets, sometimes you have to wait patiently for the time to be right. The time is finally right, as two highly qualified Elliott-wave traders have partnered to write a good book on the subject.

Wayne Gorman, who ran a major trading desk at Citibank and Westpac Banking Corporation, is head of Educational Resources at Elliott Wave International (EWI). Jeffrey Kennedy traded for a living and handles Elliott Wave Junctures, EWI’s daily educational and trade-identifying service. Both guys teach our trading seminars. And they can write well, too.

This is not a book about how some market method sets up perfect trades on paper. Wayne and Jeff walk you step by step through their thinking process during a number of trades they took in real life. They also present hypothetical setups that you might encounter in your own market experience and show you how to handle them. They aren’t easy layups but real conundrums that require thoughtful analysis and careful action. Unlike many experts, Wayne and Jeff aren’t shy about relating some of their mistakes and what they learned from them. When you read their discussions, you will know they have walked the hard road of experience.

You will also realize how much work it takes to do things right. Even if this book leads you to decide that successful trading takes too much effort, it will have provided a service. Books that make trading look easy actually cost you a lot of money in the end.

Frankly, most people are not cut out for trading. No book can cure impulsiveness, timidity, laziness, or a self-destructive personality. But this book does show you, very carefully, how two traders repeatedly negotiate the minefield of the market and come out alive and happy on the other side.

If you want to trade your own money for a living, if you want to be employable as a trader, if you just want to trade the occasional ideal setup, or even if your goal is simply to stop losing money in the markets, you are in the right place.

Successful trading takes work, discipline, and smarts. With those three things, you’re mostly there. The final thing you need is knowledge—that’s what this book provides.

Robert R. Prechter, Jr.

Elliott Wave International

Acknowledgments

We want to thank our colleagues for their valuable assistance in producing this volume: Sally Webb, Paula Roberson, Susan Walker, Cari Dobbins, Dave Allman, Debbie Hodgkins, Bob Prechter, Will Rettiger, Michael McNeilly, and Pam Greenwood.

Introduction

Welcome! Visual Guide to Elliott Wave Trading is a must-have book on how to use the Elliott Wave Principle—how to use it to find trades, assess trades, enter trades, manage trades throughout by raising or lowering protective stops, and exit trades.

Visual Guide to Elliott Wave Trading assumes a basic familiarity with the Wave Principle and its application. Much like a strategy book for chess assumes a basic knowledge of how the pieces move around the board, this book assumes a basic knowledge of the various patterns of the Wave Principle and how they fit together.

If you are already an experienced Elliott wave practitioner and simply need a refresher, the Appendix reviews these basic building blocks and their structures.

If you are a complete newcomer or you want a more in-depth review, we suggest you consult the free resources and access your free copy of the Wall Street classic Elliott Wave Principle by Frost and Prechter at your exclusive Reader Resources site: www.elliottwave.com/wave/ReaderResources.

Both of us have traded for a living at one time or another. Each of us during those times used the Elliott Wave Principle as our primary discipline. Visual Guide to Elliott Wave Trading walks you through a highly personal journey of our thought processes throughout each trade: what we looked at, what we ignored, what we did right, and what we did wrong.

We do not present perfect-world examples that will leave you convinced that you can trade your way to wealth in 30 minutes while golfing the rest of the day. Rather, we have tried to produce a realistic trading book, warts and all, recognizing that while there may be no one perfect way to trade, there are various ways to trade successfully using the Wave Principle as your primary discipline.

We hope you enjoy Visual Guide to Elliott Wave Trading. Let’s get started.

Wayne Gorman and Jeffrey Kennedy

Disclaimer

The trading examples throughout this book are solely for the purpose of demonstrating the mechanics of applying the Wave Principle. The profit or loss outcomes are not meant in any way to represent or imply a particular rate of success or return on capital.

Trade Setups

The Anatomy of Elliott Wave Trading

When teaching the Wave Principle, I begin each class by stating that analysis and trading represent two different skill sets. Although you may be a talented analyst, that does not mean you will be a successful trader and vice versa. I learned the hard way over many years that skilled analysis is a mastery of observation, while successful trading is a mastery of self.

    When it comes to trading, there is no right way or wrong way—only your way. One trader’s tolerance for risk will be starkly different from another’s, just as time frame, portfolio size, and markets traded will also be different. Thus, the guidelines offered within this chapter on how to trade specific Elliott wave patterns are just that—guidelines, but ones that have served me well for many years.

KEY POINT:

Analysis is a mastery of observation, while successful trading is a mastery of self.

    My best advice to you as you look for a trading opportunity is to start your search by asking the question, Do I see a wave pattern I recognize? You should look for one of the five core Elliott wave patterns: impulse wave, ending diagonal, zigzag, flat, or triangle. These forms will become the basis of all your trade setups once you learn to identify them quickly and with confidence.

    An even simpler question to ask is, Do I see either a motive wave or a corrective wave? Motive waves define the direction of the trend. There are two kinds of motive waves: impulse waves and ending diagonals. Corrective waves travel against the larger trend. The three kinds of corrective waves are zigzags, flats, and triangles. If all you do is identify a motive wave versus a corrective wave correctly, you can still identify some useful trade setups.

    In this chapter, we will examine how to use key components of analysis and trading to help you become a better Elliottician and a consistently successful trader. Specifically, we will examine how the Wave Principle improves trading, which waves are the best to trade, which guidelines to use for trading specific Elliott wave patterns, and why the psychology of trading and risk management—what I call the neglected essentials—are important.

How the Wave Principle Improves Trading

Every trader, every analyst, and every technician has favorite techniques to use when trading. Let’s go over why the Wave Principle is mine.

How the Wave Principle Improves Upon Traditional Technical Studies

There are three categories of technical studies: trend-following indicators, oscillators, and sentiment indicators. Trend-following indicators include moving averages, Moving Average Convergence-Divergence (MACD), and Directional Movement Index (ADX). A few of the more popular oscillators many traders use today are stochastics, rate-of-change, and the Commodity Channel Index (CCI). Sentiment indicators include put-call ratios and Commitment of Traders report data.

    Technical studies like these do a good job of illuminating the way for traders, yet they each fall short for one major reason: They limit the scope of a trader’s understanding of current price action and how it relates to the overall picture of a market. For example, let’s say the MACD reading in XYZ stock is positive, indicating the trend is up. That’s useful information, but wouldn’t it be more useful if it could also help to answer these questions: Is this a new trend or an old trend? If the trend is up, how far will it go?

    Most technical studies simply don’t reveal pertinent information such as the maturity of a trend and a definable price target—but the Wave Principle does.

Five Ways the Wave Principle Improves Trading

Here are five ways the Wave Principle can benefit you and improve your trading:

The Wave Principle identifies the trend.

It identifies countertrend price moves within the larger trend.

It determines the maturity of the trend.

It provides high-confidence price targets.

It provides specific points of invalidation.

1. Identifying the Trend

… action in the same direction as the one larger trend develops in five waves….

—Elliott Wave Principle by Frost and Prechter

    The Wave Principle identifies the direction of the dominant trend. A five-wave advance identifies the overall trend as up. Conversely, a five-wave decline determines that the larger trend is down. Why is this information important? Because it is easier to trade in the direction of the dominant trend, since it is the path of least resistance and undoubtedly explains the saying, The trend is your friend. I find trading in the direction of the trend