February 2006 ­– April 2007 Volume 3

Trader’s Classroom Collection

More Lessons from Futures Junctures

Editor Jeffrey Kennedy

Elliott Wave International © 2008

 The Trader’s Classroom Collection
Volume 3

Lessons from Futures Junctures Editor Jeffrey Kennedy

Published by

Elliott Wave International

www.elliottwave.com

The Trader’s Classroom Collection: Volume 3 — published by Elliott Wave International — www.elliottwave.com 1
 The Trader’s Classroom Collection: Volume 3

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The Elliott Wave Principle is a detailed description of how markets behave. The description reveals that mass investor psychology swings from pessimism to optimism
and back in a natural sequence, creating specific patterns in price movement. Each pattern has implications regarding the position of the market within its overall
progression, past, present and future. The purpose of this publication and its associated service is to outline the progress of markets in terms of the Elliott Wave
Principle and to educate interested parties in the successful application of the Elliott Wave Principle. While a reasonable course of conduct regarding investments
may be formulated from such application, at no time will specific recommendations or customized actionable advice be given, and at no time may a reader or caller
be justified in inferring that any such advice is intended. Readers must be advised that while the information herein is expressed in good faith, it is not guaranteed. Be
advised that the market service that never makes mistakes does not exist. Long-term success in the market demands recognition of the fact that error and uncertainty
are part of any effort to assess future probabilities.

Please note: In commodities, continuation chart wave counts often are not the same as the daily chart wave counts. This can be
because different crop years are represented on each chart, or simply because a daily chart begins its life much higher than the
current month to reflect carrying charges (or even much lower because a near term “shortage” is not expected to last until it be-
comes the lead contract).  Of course, what happens on the nearby daily chart does have to make sense within the context of what is
unfolding on the continuation charts.

The Trader’s Classroom Collection: Volume 3 — published by Elliott Wave International — www.elliottwave.com 2
A Note from Jeffrey Kennedy about Volume III…
June 2008

I enjoy analyzing price charts and making forecasts here at Elliott Wave International, but what I enjoy even more
is providing each of you with insights I’ve learned over the years. I do that in my monthly column, called Trader’s
Classroom.

It turns out that many of my subscribers like the column as much as I like writing it. That’s what gave us the idea to
collect my columns and publish them for new subscribers as The Trader’s Classroom Collection. Now we’ve pro-
duced a third volume that includes 13 columns I wrote from February 2006 to April 2007, on topics like Trading in the
Zone, The Only Technical Trade Setup You’ll Ever Need and my Annual Fibonacci Support and Resistance Levels.

Recent years have seen some of the most historically volatile times for commodities and, in turn, have provided some
of the clearest wave patterns. It has been the perfect environment to offer real-life, real-time trading lessons via the
Trader’s Classroom column in Monthly Futures Junctures. The advances in grains in 2007 offered several examples of
how important the Wave Principle and my other techniques are in identifying high-probability trading opportunities in
any financial market.

Why do I to write these columns each month? To supply you with simple tools and methods that work on any time-
frame and in any financial market, which you can apply yourselves. And remember, although I mostly use commod-
ity charts, you can apply these lessons to your favorite markets.

I hope you enjoy Volume III of The Trader’s Classroom Collection, which covers these four broad topics: 1) helping
yourself to trade better, 2) using the Wave Principle to trade, 3) high-opportunity trade setups and 4) Fibonacci-related
trading tips.

Welcome to the third edition of The Trader’s Classroom Collection,

Jeffrey Kennedy
Chief Commodity Analyst and Editor of Futures Junctures
Elliott Wave International

P.S. I have beefed up our Futures Junctures Service to include webinars and video updates as well as Commitment of
Traders data, Daily Sentiment Index data, the Futures Junctures Index of Crowd Psychology and a Trader’s Toolbox. If
you would like to receive these and the Trader’s Classroom columns as I publish them, learn more about how to subscribe
to our Futures Junctures service at http://www.elliottwave.com/wave/TCCFJ.

The Trader’s Classroom Collection: Volume 3 — published by Elliott Wave International — www.elliottwave.com 3
 CONTENTS
Page No.
5 I. How To Help Yourself Trade Better

5 1. Trading in the Zone

The Best Place for High-Opportunity Trade Setups. . . . . . . . . . . . . . . . . . . . . April 2006

7 2. Why Do Traders Fail?

Because of Inadequate Trading Systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 2006

9 3. Pick Your Poison ... and Your Protective Stops

Four Kinds of Protective Stops. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . July 2006

12 II. Using the Wave Principle To Trade

12 1. Why Do Wave Labels Change?

How a New Context Can Change Wave Labels . . . . . . . . . . . . . . . . . . . . . . . . March 2006

15 2. Take Two Steps and Then Leap

How To Recognize and Then Confirm a Wave Pattern. . . . . . . . . . . . . . . . . . . September 2006

17 3. How to Use the Thrust Measurement

Predicting Price Action Following a Contracting Triangle. . . . . . . . . . . . . . . . November 2006

19 III. High-Opportunity Trade Setups

19 1. The 10-Day Reversal

Your Own Alert to a Potential Trading Opportunity. . . . . . . . . . . . . . . . . . . . . August 2006

22 2. The Only Technical Trade Setup You’ll Ever Need

All About the MACD Hook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . October 2006

24 3. Panning for Gold

Looking for Trade Setups in Forward Month Contracts. . . . . . . . . . . . . . . . . . January 2007

26 IV. Fibonacci-related Trading Tips

26 1. Why is February the Best Month of the Year?

Time to Set Up Key Support and Resistance Levels. . . . . . . . . . . . . . . . . . . . . February 2006

29 2. 2006’s Annual Fibonacci Support and Resistance Levels

How Well Did They Work? — Part One. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 2006

31 3. 2007’s Annual Fibonacci Support and Resistance Levels

How to Use Them to Your Advantage — Part Two . . . . . . . . . . . . . . . . . . . . . February 2007

34 4. The Fibonacci Time and Price Paradigm

More About Resistance and Support Applied to the
` Canadian Dollar, Euro, Dow and Microsoft. . . . . . . . . . . . . . . . . . . . . . . . . . . April 2007

37 Appendix A — A Capsule Summary of the Wave Principle

40 Appendix B — Glossary of Terms

42 Appendix C — “What a Trader Really Needs to be Successful,” The Elliott Wave Theorist, November 1986

NOTE: Dates listed indicate the original date published in Monthly Futures Junctures.

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 I. How To Help Yourself Trade Better

1. Trading in the Zone

The Best Place for High-Opportunity Trade Setups
April 2006
Have you ever had the experience of “being in the zone”? It’s that special place of intense mental focus where it seems
that nothing else exists and that you can seemingly do no wrong. Lots of athletes talk about “being in the zone” when they
play at their peak. Some people encounter the zone while playing golf or skiing; others, while doing yard work or making
a sales call. One of my first experiences with this almost magical place came when I was a kid playing the video game
called Pac-Man. Some people talk
about “being the ball” when they hit
a great shot. Well, there were times
when I wasn’t just playing Pac-Man
– I was the Pac-Man.

So what does the zone have to do

with analysis? In my world, it’s that
special place on a price chart that
seems to offer frequent high prob-
ability trade setups. I call it The
Zone. Where do you find The Zone
on a price chart? It is the range of the
price bar that includes a long– stand-
ing price extreme.

Let’s look at Chart 1 (Wheat, daily

continuation) to see what I mean.
Notice that I drew two horizontal
lines from the high and low points of
the bar in mid-July 2005. This range
is what I call The Zone. The high of
this bar, 354, was the highest high in
Wheat in a six-month period. As you
can see, when prices revisited The
Zone between 354 and 343 in late-
September 2005, a significant sell
off resulted. This is why The Zone
of a price chart is so important; it’s
where prices often reverse.

To show you how useful and reliable

this technique is, I am including two
more charts of Wheat on different
time frames. In Chart 2, you can see
that, once you draw in The Zones
on your chart, they can prepare you
for reversals. In this case, weekly
Wheat offered three distinct trading
opportunities (i.e., two shorts and
one long).

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 I. How To Help Yourself Trade Better

On the much smaller time frame of

60 minutes, Chart 3 shows that The
Zone drawn from the lowest low
provided a high probability buy side
trade setup.

Chart 4 is even more exciting, be-

cause it demonstrates how The Zone
applies even on a 1-minute chart. As
you can see, The Zone identified two
distinct trading opportunities on the
1-minute chart of the E-mini S&P.

Since this column is called Trader’s

Classroom, I’ve decided to give each
of you some homework this month:
Take your favorite market and
identify its Zone on intraday, daily,
weekly and monthly time frames. By
doing this, you’ll be able to identify
for yourself where reversals in price
are most likely to occur ... and you’ll
be in The Zone.

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 I. How To Help Yourself Trade Better

2. Why Do Traders Fail?

Because of Inadequate Trading Systems
June 2006
I think that, as a general rule, traders fail 95% of the time, regardless of age, race, gender or nationality. The task at hand
could be as simple as learning to ride a bike for the first time or as complex as mapping the human genome. Ultimate
success in any enterprise requires that we accept failure along the way as a constant companion in our everyday lives.

I didn’t just pull this 95% figure from thin air either. I borrowed it from the work of the late, great Dr. W. Edward Dem-
ing, who is the father of Total Quality Management, commonly known as TQM. His story is quite interesting, and it
actually has a lot to do with how to trade well.

Dr. Deming graduated with degrees in electrical engineering, mathematics and mathematical physics. Then, he began
working with Walter A. Shewhart at Bell Telephone Laboratories, where he started applying statistical methods to in-
dustrial production and management. His early work with Shewhart resulted in a seminal book, Statistical Method from
the Viewpoint of Quality Control.

Since American industry spurned many of his ideas, Deming went to Japan shortly after World War II to help with early
planning for the 1951 Japanese Census. Impressed by Deming’s expertise and his involvement in Japanese society, the
Japanese Union of Scientists and Engineers invited him to play a key role in Japan’s reconstruction efforts. Deming’s
work is largely responsible for why so many high quality consumer products come from Japan even to this day.

In turn, Japanese society holds Dr. W. Edward Deming in the highest regard. The Prime Minister of Japan recognized him
on behalf of Emperor Hirohito in 1960. Even more telling, Deming’s portrait hangs in the lobby at Toyota headquarters
to this day, and it’s actually larger than the picture of Toyota’s founder.

So why do people fail? According to Deming, it’s not because people don’t try hard enough or don’t want to succeed.
People fail because they use inadequate systems. In other words, when traders fail, it’s primarily because they follow
faulty trading systems – or they follow no system at all.

So what is the right system to follow as a trader? To answer this question, I offer you what the trader who broke the all-
time real-money profit record in the 1984 United States Trading Championship offered me. He told me that a successful
trader needs five essentials:

1. A Method
You must have a method that is objectively definable. This method should be thought out to the extent that if some-
one asks how you make decisions to trade, you can quickly and easily explain. Possibly even more important, if the
same question is asked again in six months, your answer will be the same. This is not to say that the method cannot
be altered or improved; it must, however, be developed as a totality before it is implemented.

2. The Discipline to Follow Your Method

‘Discipline to follow the method’ is so widely understood by true professionals that among them it almost sounds
like a cliché. Nevertheless, it is such an important cliché that it cannot be ignored. Without discipline, you really
have no method in the first place. And this is precisely why many consistently successful traders have military
experience – the epitome of discipline.

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 I. How To Help Yourself Trade Better

3. Experience
It takes experience to succeed. Now, some people advocate “paper trading” as a learning tool. Paper trading is useful
for testing methodologies, but it has no real value in learning about trading. In fact, it can be detrimental, because
it imbues the novice with a false sense of security. “Knowing” that he has successfully paper-traded during the
past six months, the novice believes that the next six months trading with real money will be no different. In fact,
nothing could be farther from the truth. Why? Because the markets are not merely an intellectual exercise, they are
an emotional one as well. Think about it, just because you are mechanically inclined and like to drive fast doesn’t
mean you have the necessary skills to win the Daytona 500.

4. The Mental Fortitude to Accept that Losses Are Part of the Game
The biggest obstacle to successful trading is failing to recognize that losses are part of the game, and, further, that
they must be accommodated. The perfect trading system that allows for only gains does not exist. Expecting, or
even hoping for, perfection is a guarantee of failure. Trading is akin to batting in baseball. A player hitting .300 is
good. A player hitting .400 is great. But even the great player fails to hit 60% of the time! Remember, you don’t
have to be perfect to win in the markets. Practically speaking, this is why you also need an objective money man-
agement system.

5. The Mental Fortitude to Accept Huge Gains

To win the game, make sure that you understand why you’re in it. The big moves in markets come only once or twice
a year. Those are the ones that will pay you for all the work, fear, sweat and aggravation of the previous 11 months
or even 11 years. Don’t miss them for reasons other than those required by your objectively defined method. Don’t
let yourself unconsciously define your normal range of profit and loss. If you do, when the big trade finally comes
along, you will lack the self-esteem to take all it promises. By doing so, you abandon both method and discipline.
***

So who was the all-time real-money profit record holder who turned in a 444.4% return in a four-month period in 1984?
Answer: Robert Prechter ... and throughout the contest he stuck to his preferred method of analysis, the Wave Principle.
To learn more about what a successful trader really needs, refer to the November 1986 Elliott WaveTheorist Special
Report written by Robert Prechter in Appendix C.

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 I. How To Help Yourself Trade Better

3. Pick Your Poison … and Your Protective Stops

Four Kinds of Protective Stops
July 2006
I have wanted to talk about protective stops for a long time in Trader’s Classroom, because they are one of the most
difficult aspects of successful trade management. Why? Because if a protective stop is too tight, chances are you’ll get
stopped out of a trade right before the big money move you were looking for. Conversely, if a protective stop is set too
far away from where prices are currently trading, it opens you up to unnecessary market risk.

Now before I offer my 2 cents on the subject, what exactly are protective stops? Protective stops are part of a strategy that
aims to limit potential losses by setting a sell stop if you are long or a buy stop if you are short. Some traders strongly
advocate using them, primarily because protective stops saved their trading accounts on more than one occasion. Other
traders don’t use them at all, because they believe that having a protective stop in place simply gives floor traders (locals)
in the pits something to gun for, a practice referred to as “stop running.”

What exactly is stop running? It happens when floor traders who think they know where most of the resting buy or sell
stops are located in a given market try to take profits by attempting to push prices into those stops, setting them off, and
then letting the corresponding price move run its original course. Some say stop running is a myth, but on more than one
occasion, I had my own positions stopped out by two or three ticks only to see prices return to moving in the direction
I expected them to. Now, over the years of analyzing and trading, I’ve examined a number of different protective-stop
techniques. Of the four I describe here, you will probably recognize two. The other two are personal favorites that I
have developed.

1. Parabolic
The Parabolic System, also called the
Stop and Reverse (SAR) System, was
created by Welles Wilder (Chart 1).
The essence of the Parabolic System
is that it incorporates not just price but
also time. So once a trade is initiated,
it allows time for the market to react to
the change in trend and then adapts as
the trend gets underway. Simply put,
when a change in trend occurs, the
protective stop is far away from the
actual market price, but as the trend
develops over time, the stop progres-
sively tightens, thereby protecting
accrued profits.
My 2 cents: Overall, I like Parabolic as a
protective-stop technique, and I applaud
Mr. Wilder for his genius. However, person-
ally, I like my protective stops just a little
bit tighter than what Parabolic sometimes
offers.

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 I. How To Help Yourself Trade Better

2. Volatility Stop
The Volatility Stop is a com-
ponent of the Volatility Sys-
tem, also developed by Welles
Wilder. It is based on a volatility
index made up of the ongo-
ing calculated average of True
Range. (The True Range is
always positive and is defined
as the highest difference in
value among these three val-
ues: today’s daily high minus
today’s daily low, today’s daily
high minus yesterday’s closing
price, and today’s low minus
yesterday’s closing price.)
My 2 cents: The Volatility Stop is a bit
more to my liking, especially when
penetrated on a closing basis. As you
can see in Chart 2, the protective stop
identified by this technique is much
tighter than the levels offered by
Parabolic. And while this approach
to identifying protective stops is ex-
cellent in trending markets, when a
market is not trending smoothly, the
result is whipsaws – something we
saw in the first few weeks of trading
in Cocoa in early June.

3. Three Period High-Low Channel

The Three Period High-Low
Channel isn’t the brainchild of
any one analyst but stems from
my own observation of what I
consider to be tradable moves.
A tradable move is a move
where prices travel very far
very fast (i.e. impulse waves).
And as you can see in Chart 3,
since the June advance began in
Cocoa, prices have consistently
remained above the three-period low channel. What exactly is a high-low channel? It’s a channel that marks the
highest high and lowest low within a specified period of time, in this case three periods.

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 I. How To Help Yourself Trade Better

4. Five-Period Simple Moving Average

Here’s another observation in my ongoing analysis of tradable moves: I notice that when a market trends, its closes
tend to stay above a five-period simple moving average of the close. And as you can see, the levels identified in Chart
4 are significantly tighter than the levels in any of the preceding price charts. So as not to miss out on a developing
trend, I often set a protective stop a few ticks above or below the high of the first bar that successfully penetrates
the five-period moving average on a closing basis.
My 2 cents overall: As a result of many years in search of the perfect protective-stop technique, I have discovered that
there isn’t one. So when deciding which stopping technique to employ, I suggest you choose one that matches your own
trading style best.

My best advice: If there is a single gem I can offer in regard to using protective stops, it is this: If you’re confident about
a trade, give it plenty of breathing room. If you’re not, then keep your protective stops tight.

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 II. Using the Wave Principle To Trade

1. Why Do Wave Labels Change?

How A New Context Can Change Wave Labels
March 2006
One question that every Elliottician hears sooner or later is: Why did you change your wave count? Let me begin to an-
swer this question by asking one of my own: Have you ever changed your opinion about something once you had more
information? It’s called “putting things in context.”

Why is context so important? Well, let me share a story with you: Recently, I read an article in my small town local
newspaper that was intended to reveal wasteful spending by our county government. The article reported on recent pay
increases for members of the board of education. It seems that they decided to vote themselves a whopping 200% pay
increase. Naturally, the residents of our small town were infuriated, stopping just short of taking up arms and marching
on town hall.

I must admit that I got a little caught up in the herd mentality and vented my opinion at the local coffee shop along with
the other citizenry. At least I did until the context of the story was revealed.

It was true that the board of education members did vote and accept a 200% pay increase. But a few facts that provided
context were left out of the story. The board of education members voted to raise their compensation from $200 to $600
per year. Moreover, it was their first pay increase in more than 20 years, and it won’t take effect until the next board of
education members are elected.

As you can see, the proper context of any situation is vitally important for an accurate understanding of current events.
The same holds true for wave counts. What seems like a reasonable labeling in January may not seem as reasonable in
March when more price information is available.

For an example of how my wave labels change, let’s examine Charts 1 - 6 (Live Cattle) and Charts 7 - 12 (Feeder Cattle),
which come directly from the Wave Watch section of the previous six months’ worth of Monthly Futures Junctures.

You can see that, during the past six months, I made some changes in my wave counts in Cattle. Some of the changes
I made were minor, simply changing the degree of a label here and there. Other changes – for example the differences
between charts 7 and 8 (Feeder Cattle) and 9 and 10 (Feeder Cattle) – were more dramatic, because I changed wave
patterns altogether. Regardless of these changes, though, my overall bearish view in Cattle remains the same.

So why did I make adjustments to my wave counts in Cattle? Because I had more price information that helped me to
put my wave counts in a new context. As each new price bar forms – be it 60-minute, daily, weekly or monthly – it sheds
light on previous price action, thereby revealing the market’s true context. And this is why wave labels change.

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 II. Using the Wave Principle To Trade

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 II. Using the Wave Principle To Trade

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 II. Using the Wave Principle To Trade

2. Take Two Steps and Then Leap

How to Recognize and Then Confirm a Wave Pattern
September 2006
Let’s assume that you have mastered the Wave Principle, have sufficient trading capital and have determined your risk
tolerance. In other words, you’re ready to trade. What should be the first step you take in making that giant leap from
analyzing a price chart to taking a chance on an opportunity that your analysis reveals?

Steps One and Two

Your very first step is simple – you should begin with a wave pattern that you recognize. I know this step may sound
elementary, but it’s the best basis for finding a reason to trade. In fact, it is the basis of my own trading style. When
searching for a trading opportunity, I spend time quickly scanning through many price charts on multiple time frames.
Then, I sort through them until I “see” a wave pattern I recognize. In other words, Step One is to look at different charts
until a wave pattern leaps out at you.

It probably goes without saying that only a few charts exhibit an obvious, eye-catching wave pattern. When searching
for a stock trade, I might scan 100 or more price charts before a wave pattern leaps out at me – and I’ve been doing this
kind of analysis for a long time. Now, that doesn’t mean that all these price charts can’t be labeled or that they don’t have
their own distinct wave counts. It simply means that I have more confidence in a clear wave pattern.

Why the quick-scan approach? Because in my experience, I find that if you try to force-fit a labeling or a wave count on
a market, you greatly diminish the odds of a successful trade. The notion to keep in mind is, “All waves can be counted,
but all waves don’t offer a trade.”

Now for Step Two. Once you find

a wave pattern you recognize, then
you examine its validity. What I
mean by this is that you examine the
Fibonacci relationships within the
formation, and, most importantly,
you assess the wave pattern’s true
personality, either impulsive or
corrective.

The result of Step Two is confir-

mation – confirmation that your
identification is indeed correct or
recognition that you are not confi-
dent enough in your identification
to warrant initiating a trade.

Real World Example in Lean Hogs

To drive my points home, let’s re-
view the Sample Trade Strategy that
I offered to Daily Futures Junctures
subscribers on July 26, 2006. Lean
Hogs had a pattern in the daily price

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 II. Using the Wave Principle To Trade

chart that leaped out at me, so I suggested buying a break above 60.20. My hope was that subscribers could catch a rally
to initially 63.00, and ultimately well beyond that June high. Obviously, you can see from Chart 1 that this trade strategy
was fruitful (although not all are). The question is, what led me to make this recommendation in the first place?

Well, as you can see from my labeling, I recognized a wave pattern (Step One) – a Diagonal Triangle. As many of you
know, the Diagonal Triangle is my favorite Elliott wave pattern above all others because of its high probability of suc-
cess. (If you would like to learn more about Diagonal Triangles, be sure to check out my two webinars: How To Trade
Diagonal Triangles, Parts 1 and 2. Please go to www.elliottwave.com/wave/JKdiagonals.)

Chart 2 illustrates how I validated that the wave pattern was indeed a Diagonal Triangle (Step Two). What caught my
eye initially about the structure in Lean Hogs was the five-wave, overlapping move within converging trendlines – the
trademark of a Diagonal Triangle. I further noticed that it also demonstrated the personality of a corrective wave pattern
– a slow-moving price move that contains numerous overlapping waves. Finally, a number of relevant relationships stood
out after some extensive Fibonacci analysis, which you can see in Chart 2. Bottom line, closer examination supported
the initial assessment. So, confident that Lean Hogs had a Flat correction in place and that wave C of this pattern was
indeed a Diagonal Triangle that ended at 58.40, I offered a sample trade strategy.

These are exactly the same two steps that every prospective trader should take before putting hard cash on a trade. When
you trade, you always end up having to take a leap of faith. But rather than taking a leap into the unknown, you might
want to take a look at these two steps first before you leap.

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 II. Using the Wave Principle To Trade

3. How to Use the Thrust Measurement

Predicting Price Action Following a Contracting Triangle
November 2006
In this month’s feature story about
Coffee, I explain the rules, Fibonacci
relationships and guidelines that apply
when a Contracting Triangle is forming.
In this Trader’s Classroom, I’d like to
describe what happens when a Contract-
ing Triangle ends. Are there any rules
or guidelines that apply to price action
following a Contracting Triangle? The
answer to this question is a resounding
“Yes.”

When a Contracting Triangle ends, the

resultant move is often swift. Elliotti-
cians call it a Thrust, and they use an old
trick to plot its possible length, called –
are you ready? – a Thrust Measurement.
This technique simply measures the wid-
est part of the Triangle and translates it
into the length of the thrust upward or
downward from the extreme of wave E
of the pattern.

Let’s take a look at Google’s chart, and

I’ll show you what I mean. In Chart 1,
it’s easy to see that prices recently traced
out a Contracting Triangle that ended at
$363.36 in August.

1. Now the first step in calculating

the Thrust Measurement of this
triangle is to extend the trendlines
that connect the bottoms of waves A
and C and the tops of waves B and
D as illustrated in Chart 2.
2. Next, go back to the origin of
wave A in January at $475.11 and
measure the distance between the
trendlines we just extended. Then
take this length of the widest part
of the Triangle and extend it up-
ward from the extreme of wave E
at $363.36.

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 II. Using the Wave Principle To Trade

As you can see in Chart 3, the Thrust Measurement for this Contracting Triangle in Google projected a target price of
approximately $535.00. That’s it – it is indeed that simple to perform a Thrust Measurement on your own.

The only thing I can add is that the Thrust Measurement is just a ballpark figure. It is not an absolute by any means.
Prices can easily fall short of the Thrust Measurement objective or surpass it greatly. Even so, I determined over many
years that this tool is indeed worthwhile, because, more often than not, prices attain the price target it maps out.

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 III. High-Opportunity Trade Setups

1. The 10-Day Reversal

Your Own Alert to a Potential Trading Opportunity
August 2006
As many of you know, I spend
much of my spare time analyz-
ing markets. Yes, analysis is my
day job, but it is also my passion.
So, whenever the weekend rolls
around, I spend much of my time
in front of the computer studying
price charts.

What am I looking for when I

examine a price chart? I look for
“opportunity.” For an Elliottician,
opportunity on a price chart looks
like a three-wave move following
a five-wave move – in other words,
a completed wave pattern waiting
to begin its next impulsive wave.
Even so, opportunity has many
faces, some of which I outlined in
previous Trader’s Classrooms.

In this month’s issue of Trader’s

Classroom, I would like to share
with you another picture of what
opportunity looks like on a price
chart. It’s called the 10-Day Re-
versal, and it occurs when prices
make a new 10-day price extreme
but close in the opposite direction
of the 10-day trend. For example,
prices advance for 9 days, and on
day 10 they make a new high above
day nine but close below that day’s
open, preferably below the mid-
point of that day’s trading range.

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 III. High-Opportunity Trade Setups

Now the first thing I notice after

studying this bar pattern is that it’s
not as reliable as I normally like. I
tend to favor trade set-ups that are
at least 80% reliable. And as you
can see in Charts 1 - 5, I would
guesstimate the reliability of this
trade set-up at about 60%. Even so,
when the pattern does work, which
is identified by a checkmark in the
following price charts, the subse-
quent move can be quite astounding,
which is why I believe this pattern
is worth being aware of.

So rather than treat the 10-Day

Reversal as an actual trade set-up, I
recommend using it more as an alert
to a potential trade set-up. Possibly
by using the 10-Day Reversal pat-
tern in conjunction with the Wave
Principle or your favorite technical
study, the reliability of the pattern
can be increased.

And as always, whenever I define a tradable bar pattern or system, it must work across all time frames and markets,
which is why I am including price charts highlighting the 10-Day (or bar as the case may be) Reversal pattern on various
markets and on the daily, weekly and 60-minute time frames.

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 III. High-Opportunity Trade Setups

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 III. High-Opportunity Trade Setups

2. The Only Technical Trade Setup You’ll Ever Need

All About The MACD Hook
October 2006
When you come home to a dark
house, what’s the first thing you
do? You turn on the lights – you do
this, I do this, everybody does this.
Why? Because light forces back
the darkness and the imagined (and
sometimes real) monsters that lurk
in the dark. And who do we have
to thank for this seeming miracle?
Thomas A. Edison, the inventor of
the incandescent light bulb.

In addition to inventing the light

bulb, Edison should also get some
credit for the only technical trade
setup you’ll ever need: the Hook.
Maybe not credit for the whole
idea, but certainly for providing the
basis of the idea. Let me explain.

Many of you are already familiar

with the Hook or the MACD Hook
that I wrote about in countless
Daily Futures Junctures, Monthly
Futures Junctures and in Trader’s
Classroom Collection Volume II.
(Just so you’ll know, MACD stands
for Moving Average Convergence
Divergence, a popular and effec-
tive technical study developed by
Gerald Appel.)

A MACD Hook occurs when the

MACD line attempts to penetrate
the MACD Signal line but reverses
at the very last moment. Some-
times, the MACD line will pen-
etrate the Signal line for a single
period (e.g., for a day or an hour)
and reverse. In other words, the
MACD line “fails” to successfully
break through the MACD Signal line. And as I mentioned with regard to the Hook, it is a very reliable, technically based
trade set-up. See some illustrations of how it looks in Charts 1 and 2 (Cotton and Soybean Meal).

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 III. High-Opportunity Trade Setups

So how is Edison involved with the Hook? On a conceptual basis, stemming from one of his many famous quotes:

“If I find 10,000 ways something won’t work, I haven’t failed. I am not discouraged, because every wrong attempt
discarded is another step forward. Just because something doesn’t do what you planned it to do doesn’t mean it’s
useless.” - Thomas A. Edison
I interpret Edison’s words to mean
that there is no such thing as a right
or wrong answer. All information,
in its own way, is useful. It doesn’t
achieve the status of right or wrong
until it passes through our own indi-
vidual filters or judgments.

So while one could initially see the

inability of the MACD line to pen-
etrate the Signal line as a failure, in
actuality, it is a success – because
it signals a potentially successful
trade setup.

Moreover, what no one realizes

is that, as a concept, the Hook is
not limited to MACD alone. As I
illustrate in Chart 3 (Live Cattle),
Hooks can occur within just about
any technical study or indicator. In
this case, we use a 9-period Relative
Strength Index (RSI) combined with
a 20-period simple moving aver-
age, and the Hook shows up – and
is useful – just the same. A second
example in Chart 4 (E-mini Russell
2000) shows a 10/3/3 Slow Stochas-
tic that again uses the Hook.

The ability of the Hook to identify

high probability trade setups is actu-
ally limited only by your imagina-
tion, because the settings of most
technical studies can be changed
according to your own individual
preferences.

So instead of viewing financial

markets, forecasts, wave counts,
technical studies and oscillators as
right or wrong, think of them simply as information and don’t apply the labels of right or wrong. If you can learn to do
this, you’ll be amazed at out how in-sync you become with the markets. And, in doing so, you’ll find that the Hook is
indeed the only technical trade setup you’ll ever need to discover high-probability trade setups.

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 III. High-Opportunity Trade Setups

3. Panning for Gold

Looking For Trade Setups in Forward Month Contracts
January 2007
As a trader, you wear more hats than you
think you do – try analyst, accountant, stat-
istician, student, gambler and on occasion,
member of the clergy. Another hat you’ll
wear is that of a prospector, just like those
old 49ers on their way to California or the
Klondike.

The prospecting hat comes into play when

you’re in search of that next big trade, re-
gardless of whether it is in currencies, stocks,
bonds, metals or commodities. Moreover, the
opportunity you’re in search of may even
be time-dependent (i.e., a short-term trade
versus a long-term trade). In other words, just
like those old 49ers moving from stream to
stream in search of a big nugget of gold, you
spend countless hours combing through price
charts looking for that next big trade setup.

As you know, one way I look for such oppor-

tunities is by looking at price data in different
formats (for example, standard continuation
and active continuation). Another technique
is to scan markets in different scales (for
example, linear and log scale). Still another
way to pan for opportunities in financial mar-
kets is to look at forward month contracts.

The front-month contract is the futures con-

tract that is being most actively traded. How-
ever, futures have multiple contract months;
some have a contract for each month. For
example, right now, March Sugar is the front-
month contract in Sugar futures. However,
it is not the only contract being traded. You
can also trade the May 2007, July 2007 or
even the October 2007 contract. Note that
the farther out you go, volume, open inter-
est and liquidity greatly diminish. Even so,
it is possible to trade futures contracts many
months if not years into the future.

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 III. High-Opportunity Trade Setups

Why are forward months worth con-

sidering as trading opportunities?
Even though wave patterns tend to
be similar in progressive contract
months, it’s not always the case.
Notice in Chart 1 how March Wheat
has declined steadily since the Oc-
tober peak. However, if you look at
the September 2007 Wheat contract
in Chart 2, Wheat prices have done
the opposite: steadily advancing
since the October low. Moreover,
the wave patterns of March Wheat
and September Wheat are starkly
different — in recent months, Sep-
tember Wheat traced out a Diagonal
Triangle.

Lean Hogs offers another example

of why it is prudent to examine
forward month contracts. Notice in
Chart 3 the extent of the November
selloff — it more than fully retraced
the October advance. However, if
you look instead at June 2007 Lean
Hogs (Chart 4), Hog prices declined
only moderately. More importantly,
wave (4) ended just below the .382
retracement of wave (3). This con-
dition is significant because a .382
multiple of wave three is the most
common Fibonacci retracement for
fourth waves.

If you want to be a successful trader,

you must be willing to not only think
but also search outside the box. I be-
lieve that examining your basic price
chart of the front-month contract is a
thing of the past. Opportunity exists
all around us, and we must adopt
the pioneering spirit of those 49er
prospectors to go in search of high
probability trade setups – right in
front of us as well as in the future.

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 IV. Fibonacci-Related Trading Tips

1. Why Is February the Best Month of the Year?

Time To Set Up Key Support and Resistance Levels
February 2006

Winter may be great for skiers and summer may be the best time for surfers, but for an analyst like me, February is the
best month. Once February comes around, it means that January’s price action is behind us, and I can use it to map out
the next 11 months.
Last February in Trader’s Classroom, I explained that by taking Fibonacci multiples of January’s trading range, you
could identify key support and resistance levels for the entire year. I followed up in November 2005 with examples of
price charts, showing how useful this technique proved to be.

To refresh your memory, I am including charts of Orange Juice and Wheat (Charts 1 and 2). Notice in Chart 1 how the
1.618 multiple of January’s trading range provided resistance on two separate occasions in 2005, sparking reversals in
price in March and July. Also notice that when prices revisited January’s trading range in August, prices reversed sharply
and rallied right to the 4.236 multiple of January’s trading range at 126.75.

Chart 2 provides another example of how valuable this technique is. Notice that Wheat sold off three times from resis-
tance found at the 1.618 multiple of January’s trading range. And each time prices re-entered January’s trading range,
they reversed.

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 IV. Fibonacci-Related Trading Tips

How to Apply the Technique

So how do you apply this technique yourself? It’s simple: take January’s trading range (that is, subtract the low point
from the high point) and multiply that number by 1.000, 1.618, 2.618 and 4.236. Then, take these values and both add

them to January’s high and subtract them from January’s low. It’s that easy to create the year-long charts for each com-
modity you follow.

Now comes the time to heighten your awareness. As prices approach these support and resistance levels, be on the lookout
for them to reverse. Also be on the lookout when prices revisit January’s trading range. Here’s another tip: I notice that
once prices exceed the 1.000 multiple of January’s range (either up or down), prices will continue on to higher or lower
Fibonacci levels. If they don’t break the 1.000 multiple, odds favor a range-bound market.

I’m providing a list of key Fibonacci support and resistance levels for 2006 for many of the commodities I follow. As
you know, I strive to make all my tools applicable in all markets and all time frames. No surprise then – this technique
works equally well in markets that aren’t in the table. So your homework assignment for the month is to calculate the
key levels for your favorite market, such as the Dow, Gold, Crude Oil or a currency. And one more thing before I sign
off: believe it or not, this approach works equally well on individual stocks. If you take the time to prepare your charts
now, you will have a leg up on finding opportunities in your favorite markets all year long. ­

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 IV. Fibonacci-Related Trading Tips

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 IV. Fibonacci-Related Trading Tips

2. 2006’s Annual Fibonacci Support And Resistance Levels ...

How Well Did They Work? (Part One)
December 2006
In the February 2006 Trader’s Classroom, I explained
how you can identify key support and resistance levels
for the entire year in any financial market by taking Fi-
bonacci multiples of January’s trading range. That table
(shown on the previous page) identified key Fibonacci
support and resistance levels for many of the markets
I follow for 2006.

Well, as 2006 comes to an end, how did these levels

perform? Did they in fact provide support and resis-
tance? And as support and resistance, once tested, did
they ignite reversals in price or objectives for develop-
ing trends?

As you can see in Charts 1 through 5 (Cotton, Orange

Juice, Soybeans, Wheat and the Continuous Commod-
ity Index), these levels did indeed prove useful. Notice
in Chart 1 (Wheat) that the January low provided
resistance on two separate occasions in 2006 and a
2.618 multiple of January’s trading range subtracted
from January’s low offered support on two separate
occasions. In Chart 2 (Orange Juice), prices seemed to
use the 1.000, 1.618, 2.618 and 4.236 Fibonacci mul-
tiples of January’s trading range as stair steps toward a
200.00-plus objective. Chart 3 (Soybeans) is interest-
ing, because this year’s low in Soybeans occurred at
526-1/2, just three points away from January’s trading
range multiplied by .618 and subtracted from January’s
low at 523-1/2. Also, the subsequent move that resulted,
the September advance, rallied directly to Fibonacci
resistance (1.000) at 683. Charts 4 and 5 (Wheat and
the Continuous Commodity Index) provide even more
evidence that these numbers derived from January’s
trading range can help predict reversals in price.

How to Apply the Technique

So how do you apply this technique yourself? It’s
simple: take January’s trading range (that is, subtract
the low point from the high point) and multiply that
number by 1.000, 1.618, 2.618 and 4.236. If you would
like, you can even use smaller Fibonacci ratios such
as .382, .500 and .618 to provide additional levels of
support and resistance. Then, take these values and

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 IV. Fibonacci-Related Trading Tips

both add them to January’s high and

subtract them from January’s low to
identify key levels of support and
resistance in any financial market
for the entire year.

How do you use these key levels to

your advantage? As prices approach
these support and resistance levels,
be on the lookout for a possible
reversal in price (i.e., a change in
trend). If prices begin to stall as they
approach these levels, a reversal in
trend is likely. If prices slice through
these levels as if they weren’t even
there, then look for the current
trend to continue on toward the next
higher or lower number.

Also, be on the lookout when prices

revisit January’s trading range. I find
that this range also sparks reversals
in price. And here’s another tip: I
notice that once prices exceed the
1.000 multiple of January’s range
(either up or down), prices will most
likely continue on higher or lower
to the next Fibonacci level. If prices
can’t manage to exceed the 1.000
multiple of January’s trading range,
odds favor a range-bound market
for that year.

In January or February, I will publish

Part Two of this Trader’s Classroom
and provide a list of key Fibonacci
support and resistance levels for
2007 for many of the commodities I
follow. I strive to make all my tools
applicable in all markets and all time
frames, so don’t be surprised when
you discover that this technique
works equally well in all markets,
even those not found in the table
on page 28. It even works for indi-
vidual stocks. If you take the time to
prepare your charts after the first of
the year, you will have a leg up on
finding opportunities in your favorite
markets for all of 2007.

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 IV. Fibonacci-Related Trading Tips

3. 2007’s Annual Fibonacci Support and Resistance Levels

How To Use Them to Your Advantage (Part Two)
February 2007
In the December 2006 Trader’s Classroom, I explained how you can identify key support and resistance levels for the
entire year in any financial market by taking Fibonacci multiples of January’s trading range. I also illustrated how effec-
tive this technique was for 2006, based on the support and resistance levels generated at the start of the year. With this
Part Two, as promised, I bring you the key Fibonacci support and resistance levels for 2007 in each of the commodities
I follow. As the year unfolds, I hope you will keep track of them as closely as I will.

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 IV. Fibonacci-Related Trading Tips

How to Apply the Technique

So, as a quick refresher, how do you
apply this technique? Simple: Take
January’s trading range (that is,
subtract the low from the high) and
multiply that number by .618, 1.000,
1.618, 2.618 and 4.236. If you like,
you can use even smaller Fibonacci
ratios such as .236, .382 and .500
to provide additional levels of sup-
port and resistance. Then, take these
values and both add them to Janu-
ary’s high and subtract them from
January’s low to identify key levels
of support and resistance in any fi-
nancial market for the entire year. As
I mentioned before, this technique
works equally well on stock indexes,
currencies, bonds, gold, silver ...
even individual stocks.

How do you use these key levels to

your advantage? As prices approach
these support and resistance levels,
be on the lookout for a possible
reversal in price (i.e., a change in
trend). If prices begin to stall as they
approach these levels, the trend will
likely reverse. If prices slice through
these levels as if they weren’t even
there, then look for the current
trend to continue on toward the next
higher or lower number.

Also, be aware when prices revisit

January’s trading range. I find that
this range also sparks reversals in
price. And here’s another tip: once
prices exceed the 1.000 multiple of
January’s range (either up or down),
prices will most likely continue on
higher or lower to the next Fibo-
nacci level, thereby indicating that
the current trend is “entrenched.” If
prices can’t manage to exceed the
1.000 multiple of January’s trading
range, odds favor a range-bound
market for that year.

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 IV. Fibonacci-Related Trading Tips

In the Wave Watch section of each

issue of Monthly Futures Junctures,
I update the weekly and daily Elliott
wave labelings for each of the com-
modity markets I follow. Now if we
combine those Elliott wave label-
ings with the Annual Fibonacci Sup-
port and Resistance levels, we can
get a better idea of how and where
prices will travel. See Charts 1, 2,
3 and 4 for examples. Furthermore,
these Annual Fibonacci Support and
Resistance levels can be combined
with internal wave projections of
any time frame to more accurately
identify “clusters” of Fibonacci
support and resistance. For those of
you who aren’t aware, a “cluster”
of Fibonacci support or resistance
occurs when multiple Fibonacci
retracement or extension levels fall
in a general area. From my experi-
ence, the more tightly bound these
areas are, the more significant they
are, often resulting in reversals in
price.

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 IV. Fibonacci-Related Trading Tips

4. The Fibonacci Time and Price Paradigm

More About Resistance and Support Applied to the Canadian Dollar,
Euro, Dow And Microsoft
April 2007
“Does it really work on all markets, including individual stocks?” That’s the question asked the most by subscribers who
e-mailed me about the technique I detailed in the February 2007 Trader’s Classroom. In that issue, I explained how you
could identify key support and resistance levels for the entire year in any financial market by taking Fibonacci multiples
of January’s trading range. I also provided a list of these levels for each of the commodity markets I follow.

My answer to the question is a resounding, “Yes!” To show how effective this technique truly is, I am including long-term
charts of the Canadian Dollar, Euro, Dow Jones Industrial Average and Microsoft in this month’s Trader’s Classroom.

But before I explain again how to use this approach yourself, let me draw your attention to the title of this month’s article:
“The Fibonacci Time and Price Paradigm.” Why such a formal title? Well, as my work and research on this technique
continues, I feel it necessary to give it a name. But why the word “paradigm”? Once you boil down the official Merriam-
Webster’s dictionary definition, you get that a paradigm is simply a philosophical or theoretical framework for theories,
laws and generalizations, as well as experiments to support them. And since I believe that, as analysts, we have only
scratched the surface of what technical analysis has to offer, I think paradigm is the right word to show that I expect
there to be further discoveries about this technique and its uses.

How To Apply the Paradigm

How do you apply the Fibonacci Time and Price Paradigm? Simple: Take January’s trading range (that is, subtract the
low from the high) and multiply that number by these Fibonacci ratios: .618, 1.000, 1.618, 2.618 and 4.236. If you like,
you can use even smaller Fibonacci ratios, such as .236, .382 and .500 to provide additional levels of support and resistance.
Then, take these values and both add them to January’s high and subtract them from January’s low to identify key levels
of support and resistance in any financial market for the entire year.

As an added exercise: I also find that Fibonacci retracements of January’s trading range itself (without adding it to Janu-
ary’s high or subtracting it from the low) often identify significant levels of support and resistance (i.e., .382, .500 and
.618).

How do you use these key levels to your advantage?

• As prices approach these support and resistance levels, be on the lookout for a possible reversal in price (i.e., a
change in trend).
• If prices begin to stall as they approach these levels, the trend will likely reverse.
• If prices slice through these levels as if they weren’t even there, then look for the current trend to continue on
toward the next higher or lower number.

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 IV. Fibonacci-Related Trading Tips

The Importance of January’s Trading Range

Also, be aware when prices revisit January’s trading range. I find that this range also sparks reversals in price, as it did
in 2002 in the Canadian Dollar (Chart 1). And here’s another tip: Once prices exceed the 1.000 multiple of January’s
range (either up or down), prices will most likely continue on higher or lower to the next Fibonacci level, thereby in-
dicating that the current trend is “entrenched,” which occurred in 2002, 2003, 2005 and 2006 in the Euro (Chart 2). If
prices can’t manage to exceed the 1.000 multiple of January’s trading range, as it did in 2004, odds favor a range-bound
market for that year.

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 IV. Fibonacci-Related Trading Tips

In addition to realizing how important the 1.000 multiple of January’s trading range is, I also uncovered numerous in-
stances in which the January high or low provides significant resistance and support, much as it did in 2004, 2005 and
2006 in the Dow Jones Industrial Average (Chart 3). This tendency can also be seen again in 2003 in Microsoft (MSFT,
Chart 4).

Remember, just like you, day after day, year after year, I sit and watch price action unfold on the screen in front of me.
Why? Because my work is my passion and because I sense something about the markets that is exciting, mysterious
and alluring. If this chord rings true for you, please spend some time exploring this approach to discover how it can
best work for you. You may be the one who unravels a mystery or discovers a nuance about the markets that no other
technical analyst ever has.

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 Appendix A — A Capsule Summary of the Wave Principle

Appendix A
A Capsule Summary of the Wave Principle
The Wave Principle is Ralph Nelson Elliott’s discovery that social, or crowd, behavior trends and reverses in recognizable
patterns. Using stock market data as his main research tool, Elliott isolated thirteen patterns of movement, or “waves,”
that recur in market price data. He named, defined and illustrated those patterns. He then described how these structures
link together to form larger versions of those same patterns, how those in turn link to form identical patterns of the next
larger size, and so on. In a nutshell, then, the Wave Principle is a catalog of price patterns and an explanation of where
these forms are likely to occur in the overall path of market development.

Pattern Analysis
Until a few years ago, the idea that market movements are patterned was highly controversial, but recent scientific
discoveries have established that pattern formation is a fundamental characteristic of complex systems, which include
financial markets. Some such systems undergo “punctuated growth,” that is, periods of growth alternating with phases
of non-growth or decline, building fractally into similar patterns of increasing size. This is precisely the type of pattern
identified in market movements by R.N. Elliott some sixty years ago.

The basic pattern Elliott described consists of impulsive waves (denoted by numbers) and corrective waves (denoted by
letters). An impulsive wave is composed of five subwaves and moves in the same direction as the trend of the next larger
size. A corrective wave is composed of three subwaves and moves against the trend of the next larger size. As Figure
A-1 shows, these basic patterns link to form five- and three-wave structures of increasingly larger size (larger “degree”
in Elliott terminology).

In Figure A-1, the first small se-

quence is an impulsive wave ending
at the peak labeled 1. This pattern
signals that the movement of one
larger degree is also upward. It also
signals the start of a three-wave cor-
rective sequence, labeled wave 2.

Waves 3, 4 and 5 complete a larger

impulsive sequence, labeled wave
(1). Exactly as with wave 1, the
impulsive structure of wave (1) tells
us that the movement at the next
larger degree is upward and signals
the start of a three-wave corrective
downtrend of the same degree as
wave (1). This correction, wave (2),
is followed by waves (3), (4) and (5)
to complete an impulsive sequence
of the next larger degree, labeled
wave 1. Once again, a three-wave
Figure A-1 correction of the same degree oc-
curs, labeled wave 2. Note that
at each “wave one” peak, the implications are the same regardless of the size of the wave. Waves come in degrees, the
smaller being the building blocks of the larger. Here are the accepted notations for labeling Elliott wave patterns at every
degree of trend (see Figure A-2):

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 Appendix A — A Capsule Summary of the Wave Principle

Figure A-2
Within a corrective wave, waves A and C may be smaller-degree impulsive waves, consisting of five subwaves. This
is because they move in the same direction as the next larger trend, i.e., waves (2) and (4) in the illustration. Wave B,
however, is always a corrective wave, consisting of three subwaves, because it moves against the larger downtrend.
Within impulsive waves, one of the odd-numbered waves (usually wave three) is typically longer than the other two.
Most impulsive waves unfold between parallel lines except for fifth waves, which occasionally unfold between converg-
ing lines in a form called a “diagonal triangle.” Variations in corrective patterns involve repetitions of the three-wave
theme, creating more complex structures that are named with such terms as “zigzag,” “flat,” “triangle” and “double
three.” Waves two and four typically “alternate” in that they take different forms.

Each type of market pattern has a name and a geometry that is specific and exclusive under certain rules and guidelines,
yet variable enough in other aspects to allow for a limited diversity within patterns of the same type. If indeed markets
are patterned, and if those patterns have a recognizable geometry, then regardless of the variations allowed, certain rela-
tionships in extent and duration are likely to recur. In fact, real world experience shows that they do. The most common
and therefore reliable wave relationships are discussed in Elliott Wave Principle, by A.J. Frost and Robert Prechter.

Applying the Wave Principle

The practical goal of any analytical method is to identify market lows suitable for buying (or covering shorts), and mar-
ket highs suitable for selling (or selling short). The Elliott Wave Principle is especially well suited to these functions.
Nevertheless, the Wave Principle does not provide certainty about any one market outcome; rather, it provides an objec-
tive means of assessing the relative probabilities of possible future paths for the market. At any time, two or more valid
wave interpretations are usually acceptable by the rules of the Wave Principle. The rules are highly specific and keep the
number of valid alternatives to a minimum. Among the valid alternatives, the analyst will generally regard as preferred
the interpretation that satisfies the largest number of guidelines and will accord top alternate status to the interpretation
satisfying the next largest number of guidelines, and so on.

Alternate interpretations are extremely important. They are not “bad” or rejected wave interpretations. Rather, they are
valid interpretations that are accorded a lower probability than the preferred count. They are an essential aspect of invest-
ing with the Wave Principle, because in the event that the market fails to follow the preferred scenario, the top alternate
count becomes the investor’s backup plan.

Fibonacci Relationships
One of Elliott’s most significant discoveries is that because markets unfold in sequences of five and three waves, the
number of waves that exist in the stock market’s patterns reflects the Fibonacci sequence of numbers (1, 1, 2, 3, 5, 8, 13,
21, 34, etc.), an additive sequence that nature employs in many processes of growth and decay, expansion and contraction,
progress and regress. Because this sequence is governed by the ratio, it appears throughout the price and time structure
of the stock market, apparently governing its progress.

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 Appendix A — A Capsule Summary of the Wave Principle

What the Wave Principle says, then, is that mankind’s progress (of which the stock market is a popularly determined
valuation) does not occur in a straight line, does not occur randomly, and does not occur cyclically. Rather, progress takes
place in a “three steps forward, two steps back” fashion, a form that nature prefers. As a corollary, the Wave Principle
reveals that periods of setback in fact are a requisite for social (and perhaps even individual) progress.

Implications
A long-term forecast for the stock market provides insight into the potential changes in social psychology and even
the occurrence of resulting events. Since the Wave Principle reflects social mood change, it has not been surprising to
discover, with preliminary data, that the trends of popular culture that also reflect mood change move in concert with
the ebb and flow of aggregate stock prices. Popular tastes in entertainment, self-expression and political representation
all reflect changing social moods and appear to be in harmony with the trends revealed more precisely by stock market
data. At one-sided extremes of mood expression, changes in cultural trends can be anticipated.

On a philosophical level, the Wave Principle suggests that the nature of mankind has within it the seeds of social change.
As an example simply stated, prosperity ultimately breeds reactionism, while adversity eventually breeds a desire to
achieve and succeed. The social mood is always in flux at all degrees of trend, moving toward one of two polar opposites
in every conceivable area, from a preference for heroic symbols to a preference for anti-heroes, from joy and love of life
to cynicism, from a desire to build and produce to a desire to destroy. Most important to individuals, portfolio managers
and investment corporations is that the Wave Principle indicates in advance the relative magnitude of the next period of
social progress or regress.

Living in harmony with those trends can make the difference between success and failure in financial affairs. As the
Easterners say, “Follow the Way.” As the Westerners say, “Don’t fight the tape.” In order to heed these nuggets of advice,
however, it is necessary to know what is the Way, and which way the tape. There is no better method for answering that
question than the Wave Principle.

To obtain a full understanding of the Wave Principle including the terms and patterns, please read Elliott Wave Principle
by A.J. Frost and Robert Prechter, or take the free Comprehensive Course on the Wave Principle on the Elliott Wave
International website at www.elliottwave.com.

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 Appendix B — Glossary Of Terms

Appendix B
Glossary Of Terms
Alternation (guideline of) - If wave two is a sharp correction, wave four will usually be a sideways correction, and
vice versa.

Apex - Intersection of the two boundary lines of a contracting triangle.

Corrective Wave - A three-wave pattern, or combination of three wave patterns, that moves in the opposite direction
of the trend of one larger degree.

Diagonal Triangle (Ending) - A wedge-shaped pattern containing overlap that occurs only in fifth or C waves. Subdi-
vides 3-3-3-3-3.

Diagonal Triangle (Leading) - A wedge-shaped pattern containing overlap that occurs only in first or A waves. Subdi-
vides 5-3-5-3-5.

Double Three - Combination of two simple sideways corrective patterns, labeled W and Y, separated by a corrective
wave labeled X.

Double Zigzag - Combination of two zigzags, labeled W and Y, separated by a corrective wave labeled X.

Equality (guideline of) - In a five-wave sequence, when wave three is the longest, waves five and one tend to be equal
in price length.

Expanded Flat - Flat correction in which wave B enters new price territory relative to the preceding impulse wave.

Failure - See Truncated Fifth.

Flat - Sideways correction labeled A-B-C. Subdivides 3-3-5.

Impulse Wave - A five-wave pattern that subdivides 5-3-5-3-5 and contains no overlap.

Impulsive Wave - A five-wave pattern that makes progress, i.e., any impulse or diagonal triangle.

Irregular Flat - See Expanded Flat.

One-two, one-two - The initial development in a five-wave pattern, just prior to acceleration at the center of wave
three.

Overlap - The entrance by wave four into the price territory of wave one. Not permitted in impulse waves.

Previous Fourth Wave - The fourth wave within the preceding impulse wave of the same degree. Corrective patterns
typically terminate in this area.

Sharp Correction - Any corrective pattern that does not contain a price extreme meeting or exceeding that of the ending
level of the prior impulse wave; alternates with sideways correction.

Sideways Correction - Any corrective pattern that contains a price extreme meeting or exceeding that of the prior im-
pulse wave; alternates with sharp correction.

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 Appendix B — Glossary Of Terms

Third of a Third - Powerful middle section within an impulse wave.

Thrust - Impulsive wave following completion of a triangle.

Triangle (contracting, ascending or descending) - Corrective pattern, subdividing 3-3-3-3-3 and labeled A-B-C-D-E.
Occurs as a fourth, B, X (in sharp correction only) or Y wave. Trendlines converge as pattern progresses.

Triangle (expanding) - Same as other triangles, but trendlines diverge as pattern progresses.

Triple Three - Combination of three simple sideways corrective patterns labeled W, Y and Z, each separated by a cor-
rective wave labeled X.

Triple Zigzag - Combination of three zigzags, labeled W, Y and Z, each separated by a corrective wave labeled X.

Truncated Fifth - The fifth wave in an impulsive pattern that fails to exceed the price extreme of the third wave.

Zigzag - Sharp correction, labeled A-B-C. Subdivides 5-3-5.

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 Appendix C
Appendix C — “What A Trader Really Needs To Be Successful,” The Elliott Wave Theorist, November 1986

© November 1986

SPECIAL REPORT

WHAT A TRADER REALLY NEEDS TO BE SUCCESSFUL

Ever since winning the United States Trading Championship in 1984 (see footnotes, p.4), subscribers have asked for a
list of “tips” on trading, or even a play-by-play of the approximately 200 short term trades I made while following hourly
market data over a four month period. Neither of these would do anyone any good. What successful trading requires
is both more and less than most people think. In watching the reports of each new Championship over the past three
years, it has been a joy to see what a large percentage of the top winners have been Elliott Wave Theorist subscribers and
telephone consultation customers. (In fact, in the latest “standings” report from the USTC, of the top three producers
in each of four categories, half are EWT subscribers!) However, while good traders may want the input from EWT, not
all EWT subscribers are good traders. Obviously the winners know something the losers don’t. What is it? What are the
guidelines you really need to meet in order to trade the markets successfully?

When I first began trading, I did what many others who start out in the markets do: I developed a list of trading rules.
The list was created piecemeal, with each new rule added, usually, following the conclusion of an unsuccessful trade.
I continually asked myself, what would I do differently next time to make sure that this mistake would not recur? The
resulting list of “do’s” and “don’ts” ultimately comprised about 16 statements. Approximately six months following the
completion of my carved-in-stone list of trading rules, I balled up the paper and threw it in the trash.

What was the problem with my list, a list typical of so many novices who think they are learning something? After several
months of attempting to apply the “rules,” it became clear that I made not merely a mistake here and there in the list,
but a fundamental error in compiling the list in the first place. The error was in taking aim at the last trade each time, as
if the next trading situation would present a similar problem. By the time 16 rules are created, all situations are covered
and the trader is back to square one.

Let me give you an example of the ironies that result from the typical method of generating a list of trading rules. One
of the most popular trading maxims is, “You can’t go broke taking a profit.” (The brokers invented that one, of course,
which is one reason that new traders always hear of it!) This trading maxim appears to make wonderful sense, but only
when viewed in the context of a recent trade with a specific outcome. When you have entered a trade at a good price,
watched it go your way for a while, then watched it go against you and turn into a loss, the maxim sounds like a pro-
nouncement of divine wisdom. What you are really saying, however, is that in the context of the last trade, “I should
have sold when I had a small profit.”

Now let’s see what happens on the next trade. You enter a trade, and after just a few days of watching it go your way,
you sell out, only to stare in amazement as it continues to go in the direction you had expected, racking up paper gains
of several hundred percent. You ask a more experienced trader what your error was, and he advises you sagely while

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 Appendix C — “What A Trader Really Needs To Be Successful,” The Elliott Wave Theorist, November 1986

peering over his glasses, “Remember this forever: Cut losses short; let profits run.” So you reach for your list of trading
rules and write this maxim, which means only, of course, “I should NOT have sold when I had a small profit.”

So trading rules #2 and #14 are in direct conflict. Is this an isolated incident? What about rule #3, which reads, “Stay
cool; never let emotions rule your trading,” and #8, which reads, “If a trade is obviously going against you, get out of
the way before it turns into a disaster.” Stripped of their fancy attire, #3 says, “Don’t panic during trading,” and #8 says,
“Go ahead and panic!” Such formulations are, in the final analysis, utterly useless.

What I finally desired to create was a description not of each of the trees, but of the forest. After several years of trad-
ing, I came up with —guess what— another list! But this is not a list of “trading rules”; it’s a list of requirements for
successful trading. Most worthwhile truths are simple, and this list contains only five items. (In fact, the last two are
actually subsets of the first two.) Whether this list is true or complete is arguable, but in forcing myself to express my
conclusions, it has helped me understand the true dimensions of the problem, and thus provided a better way of solving
it. Like most rewards life offers, market profits are not as easy to come by as the novice believes. Making money in
the market requires a good deal of education, like any craft or business. If you’ve got the time, the drive, and the right
psychological makeup, you can enter that elite realm of the truly professional, or at least successful, trader or investor.
Here’s what you need:

1. A method.
I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how
you make your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same
answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality be-
fore it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable.
People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step
of obtaining a method. I chose to use, for my decision making, an approach which was explained in our book, Elliott
Wave Principle. I think the Wave Principle is the best way to understand the framework of a market and where prices are
within that framework. There are a hundred other methods which will work if successful trading is your only goal. As
I have often said, a simple 10-day moving average of the daily advance-decline net, probably the first indicator a stock
market technician learns, can be used as a trading tool, if objectively defined rules are created for its use. The bad news
is that as difficult and time consuming as this first major requirement can be, it is the easiest one to fulfill.

2. The discipline to follow your method.

This requirement is so widely understood by the true professionals that among them, it almost sounds like a cliche´ .
Neverthless, it is such an important cliche´ that it cannot be sidestepped, ignored, or excepted. Without discipline, you
really have no method in the first place. It struck me one day that among a handful of consistently successful professional
options and futures traders of my acquaintance, three of them are former Marines. In fact, the only advisor, as ranked by
Commodity Traders Consumer Report, consistently to beat my Telephone Hotline record from 1983 to 1985 was a former
Marine as well (he has retired from the advisory business). Now, this is a ratio way out of proportion to former Marines
as a percentage of the general population! Why should this anomaly exist? Think about it. At some point in their lives,
these people volunteered to serve in an organization which requires, above all, discipline. These are people who asked for
the opportunity to go charging through a jungle pointing a bayonet and pitching grenades, surviving on roots and bugs
when necessary. That’s an overdramatization perhaps, but you get the point. These people knew they were “tough,” and
wanted the chance to prove it. Being “tough” in this context means having the ability to suppress a host of emotions in
order to act in a manner which would strike fear in the hearts of most people. I was never a Marine, but years ago while
attending summer school with Georgia’s “Governor’s Honors Program,” I was given a psychological test and told that
one of my skewed traits was “tough-mindedness” (as opposed to “tender-mindedness”). I didn’t exactly know what that
meant, but after trading and forecasting the markets for fourteen years, it is clear that without that trait, I would have
been forced long ago to elect another profession. The pressures are enormous, and they get to everyone, including me.
If you are not disciplined, forget the markets.

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 Appendix C — “What A Trader Really Needs To Be Successful,” The Elliott Wave Theorist, November 1986

3. Experience.
Some people advocate “paper trading” as a learning tool. Paper trading is useful for the testing of methodology, but it is
of no value in learning about trading. In fact, it can be detrimental, by imbuing the novice with a false sense of security
in “knowing” that he has successfully paper traded the past six months, thus believing that the next six months with real
money will be no different. In fact, nothing could be further from the truth. Why? Because the markets are not merely
an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. If you buy a computer
baseball game and become a hitting expert with the joystick while sitting quietly alone on the floor of your living room,
you may conclude that you are one talented baseball player. Now let the Mean Green Giant reach in, pick you up, and
place you in the batter’s box at the bottom of the ninth inning in the final game of the World Series with your team be-
hind by one run, the third base coach flashing signals one after another, a fastball heading toward your face at 90 m.p.h.,
and sixty beer soaked fans in the front row screaming, “Yer a bum! Yer a bum!” Guess what? You feel different! To put
it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living
room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being
bombarded with stimuli. This is what your life is like when you are actually speculating. You know it is real, you know
it matters, you must physically pick up the phone and speak to place orders, you perform under the scrutiny of your bro-
ker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages
are thrown at you from the financial media, the brokerage industry, analysts, and the market itself. In short, you must
conquer a host of problems, most of them related to your own inner strength in battling powerful human emotions, in
order to trade real money successfully. The School of Hard Knocks is the only school that will teach it to you, and the
tuition is expensive.

There is only one shortcut to obtaining experience, and that is to find a mentor. Locate someone who has proved himself
over the years to be a successful trader or investor, and go visit him. You will undoubtedly find that he is very friendly
since his runaway ego of yesteryear, which undoubtedly got him involved in the markets in the first place, has long since
been humbled, matured by the experience of trading. Watch this person operate. Observe not only what he does, but far
more important, what he does not allow himself to do. This person does exist, but it is hard to find him. He will usually
welcome the opportunity to tell you what he knows.

4. The Mental Fortitude to Accept the Fact that Losses Are Part of the Game.
There are many denials of reality which automatically disqualify millions of people from joining the ranks of successful
speculators. For instance, to moan that “pools,” “manipulators,” “insiders,” “they,” “the big boys” or “program trading”
are to blame for one’s losses is a common fault. Anyone who utters such a conviction is doomed before he starts. But my
observation, after eleven years “in the business,” is that the biggest obstacle to successful speculation is the failure merely
even to recognize and accept the simple fact that losses are part of the game, and that they must be accommodated. The
perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Speculation is
akin to batting in baseball. A player hitting .300 is good. A player hitting .400 is great. But even the great player fails
to hit 60% of the time! He even strikes out often. But he still earns six figures a year, because although not perfect, he
has approached the best that can be achieved. You don’t have to be perfect to win in the markets, either; you “merely”
have to be better than almost everybody else, and that’s hard enough. Practically speaking, you must include an objec-
tive money management system when formulating your trading method in the first place. There are many ways to do it.
Some methods use stops. If stops are impractical (such as with options), you may decide to risk only small amounts of
total capital at a time. After all is said and done, learning to handle losses will be your greatest triumph.

The last on my list is one I have never heard mentioned before.

5. The Mental Fortitude to Accept Huge Gains.

This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually
to be a problem. But consider. How many times has the following sequence of events occurred? For a full year, you trade
futures contracts, making $1000 here, losing $1500 there, making $3000 here and losing $2000 there. Once again, you

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 Appendix C — “What A Trader Really Needs To Be Successful,” The Elliott Wave Theorist, November 1986

enter a trade because your method told you to do so. Within a week, you’re up $4000. Your friend/partner/acquaintance/
broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though,
and you wait. The following week, your position is up $8000, the best gain you have ever experienced. “Get out!” says
your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit against you. Your
friend calls and says, “I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.” The
next day, on the opening, you exit the trade, taking a $5000 profit. It’s your biggest profit of the year, and you click your
heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue
to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six
months, your method finally, quietly, calmly says, “Get out.” You check the figures and realize that your initial entry, if
held, would have netted $450,000.

So what was your problem? Simply that you had allowed yourself unconsciously to define your “normal” range of profit and
loss. When the big trade finally came along, you lacked the self esteem to take all it promised. You looked at a job requir-
ing the services of a Paul Bunyan and decided that you were just a Pee Wee Herman. Who were you to shoot for such huge
gains? Why should you deserve more than your best trade of the year? You then abandoned both method and discipline.

To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a
year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months
or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method.

The I.R.S. categorizes capital gains as “unearned income.” That’s baloney. It’s hard to make money in the market. Every
dime you make, you richly deserve. Don’t ever forget that. I wish you success.

______________________
In 1984, Bob Prechter won the United States Trading Championship, setting a new all-time profit record of 444.4%
in a monitored real money options account in four months. That February through May period presented a dif-
ficult and choppy market to the effect that the second highest reported gain in the options division was just
84%, and 83% of the contestants lost money. According to contest sponsors, many market letter writers have
entered the contest over the years, but almost all have lost money. In the average 4-month contest, over 75% of
contestants, most of whom are professionals paying $200 to prove their abilities, fail to report profits.

I highly recommend the United States Trading Championship. It is the only trading contest which fairly allows
each entrant to perform at his maximum ability, without arbitrary constraints. Most others are started by bro-
kerage firms to create business; they impose minimum accounts, insist on trading one type of vehicle, etc. For
information on the USTC, contact the Financial Traders Association, P.O. Box 7634, Beverly Hills, CA 90212-7634;
phone 310-550-0062

THE ELLIOTT WAVE THEORIST is published by Elliott Wave International, Inc. Mailing address: P.O. Box
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International, Inc. Reproduction, retransmission or redistribution in any form is illegal and strictly forbidden, as
is continuous and regular dissemination of specific forecasts or strategies. Otherwise, feel free to quote, cite or
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The Elliott Wave Principle is a detailed description of how markets behave. The description reveals that mass investor psychology swings from pessimism to op-
timism and back in a natural sequence, creating specific patterns in price movement. Each pattern has implications regarding the position of the market within its
overall progression, past, present and future. The purpose of this publication and its associated services is to outline the progress of markets in terms of the Elliott
Wave Principle and to educate interested parties in the successful application of the Elliott Wave Principle. While a reasonable course of conduct regarding invest-
ments may be formulated from such application, at no time will specific security recommendations or customized actionable advice be given, and at no time may a
reader or caller be justified in inferring that any such advice is intended. Readers must be advised that while the information herein is expressed in good faith, it is
not guaranteed. Be advised that the market service that never makes mistakes does not exist. Long-term success in the market demands recognition of the fact that
error and uncertainty are part of any effort to assess future probabilities.

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