A Beginners Guide Harmonic Patterns In Trading

Most Classical Technical Trading patterns are Breakout pattern and are more vulnerable to failure, whipsaws or false break. Harmonic Trading Patterns are reversals patterns which Identify Potential Reversal Zones to Sell when Markets are rising and Buy when markets are falling. These exhaustion trades give you the Best Entry to enter the trade (Sometimes right at the top or bottom) with an Amazing Risk Reward ratio. All technical analysis studies are Probabilistic in nature and there are always going to be few patterns which would fail. But the Harmonic Trading pattern offers a very good hit ratio with the pattern occurrence and will make you lose very little when you are wrong as compared to what you Gain when the Pattern Works. Fibonacci is the very foundation of the design of our nature which also works in Stock Markets. These magnificent Fibonacci combinations offer one of the Best Trade Setups you can ever trade in all Time Frames using the Harmonic Trading.

Below is the listed each and every Harmonic pattern in detail.

  1. AB=CD
  2. ALTERNATE AB=CD
  3. BAT
  4. GARTLEY
  5. BUTTERFLY
  6. CRAB
  7. SHARK
  8. 3 DIVES

AB=CD  PATTERN

The AB=CD Pattern is one of the classic chart patterns which is repeated over and over again. The pattern consists of three legs, with two equal legs labelled AB and CD, together they form a zig-zag shape.

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CHARACTERISTICS  OF  AB=CD  PATTERN 

  • AB SHOULD BE EQUAL TO CD
  • C POINT CAN  RETRACE  BETWEEN  382  TO  0.886 OF AB
  • BC PROJECTION CAN  BE BETWEEN 13 TO 3.14
  • BC PROJECTION SHOULD CONVERGE AT THE COMPLETION OF AB=CD
  • POINT D  IS KNOWN AS THE PRZ OR POTENTIAL REVERSAL ZONE
  • A 618 RETRACEMENT  AT THE C POINT WILL RESULT IN A 1.618  BC PROJECTION
  • A 786 RETRACEMENT  AT THE C POINT WILL RESULT IN A 1.27  BC PROJECTION
  • An 886 RETRACEMENT  AT THE C POINT WILL RESULT IN A 1.13  BC PROJECTION

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TRADING  AB=CD  PATTERN

  • POINT D WHICH IS THE PRZ IS THE BUYING OR (SELLING) POINT
  • EXIT IF PRICE CLOSES BELOW OR (ABOVE) THE LOW OR (HIGH) OF POINT D
  • PROFIT TARGET IS GENERALLY 2% TO 61.8% OF CD LEG OF THE PATTERN.

BULLISH  AB=CD  PATTERN  IN  NIFTY
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BEARISH  AB=CD  PATTERN  IN  MAHINDRA AND MAHINDRA
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ALTERNATE AB=CD6

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The Alternative AB=CD Pattern is exactly the same as the AB=CD pattern. The most noticeable difference between the alternative AB=CD and the regular AB=CD is the length of the CD leg. There are different Fibonacci ratios that create the reversal point. The turning point can be a 1.27 or a 1.618 extension and that will depend on the length of the retracement connecting the AB leg to the CD leg.

ALTERNATE AB=CD PATTERN BASICS

  • RETRACEMENT OF AB SHOULD BE 2% TO 88.6%, ALTHOUGH 61.8% IS PREFERRED.
  • RETRACEMENT OF BC SHOULD BE 113% TO 314%.
  • PROJECTION OF AB SHOULD BE 127% OR 8%.
  • PRZ D SHOULD BE THE OVERLAPPING ZONE OF BC RETRACEMENT AND AB

TRADING THE ALTERNATE AB=CD PATTERN

  • PRZ D IS THE BUYING OR SELLING ZONE.
  • THE TARGET SHOULD BE 38.2% TO 88.6% OF THE ENTIRE PATTERN.
  • THE STOP LOSS SHOULD BE JUST BELOW THE PRZ.

BEARISH  ALTERNATE AB=CD  PATTERN  IN  NIFTY  DAILY  CHART
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BAT  PATTERN

The BAT Pattern is considered to be one of the most accurate patterns exhibiting a higher success rate than any other harmonic patterns and requires a smaller stop loss than most patterns. It is made up of 5 swing points, X, A, B, C and D and come in Bullish and Bearish BAT variations. The pattern incorporates the 0.886 XA  RETRACEMENT ,  as the defining element in the POTENTIAL REVERSAL  ZONE (PRZ).

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CHARACTERISTICS  OF  BAT  PATTERN

  • THE B POINT RETRACEMENT MUST BE LESS THAN A 618, PREFERABLY A 0.50 OR 0.382 OF THE XA LEG.
  • BC LEG CAN RETRACE BETWEEN 382 TO 0.886 OF AB LEG.
  • BC PROJECTION SHOULD BE BETWEEN 618 TO 2.618 TO FORM D.
  • CD LEG SHOULD RETRACE UPTO .886 OF XA LEG
  • IN ADDITION, THE AB=CD PATTERN WITHIN THE BAT IS EXTENDED AND USUALLY REQUIRES A 27AB=CD CALCULATION
  • POINT D IS THE PRZ OR POTENTIAL REVERSAL ZONE WHERE BC PROJECTION AND 886 RETRACEMENT OF XA OVERLAPS.

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TRADING THE BAT PATTERN

  • PRZ (D POINT) IS THE BUYING OR (SELLING) ZONE.
  • STOP LOSS IS THE LOW OR (HIGH) OF
  • PROFIT TARGET
  • TARGET 1= 2%-61.8% RETRACEMENT OF CD
  • TARGET2= 8% RETRACEMENT OF AD
  • TARGET 3= PROJECTED XA DISTANCE FROM THE PRZ LEVEL AT D

BULLISH  BAT  PATTERN  IN  GAIL  DAILY  CHART

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BEARISH  BAT  PATTERN  IN  HDFC DAILY  CHART

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GARTLEY  PATTERN

The GARTLEY is made up of a series of price reversals and the retracement percentages that establish an ideal pattern. The specific retracements of the B point at a 0.618 and the D point at a 0.786 were assigned to the pattern.

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CHARACTERISTICS  OF GARTLEY  PATTERN 

  • PRECISE 618 B POINT RETRACEMENT OF XA LEG.
  • C POINT WITHIN RANGE OF 382-0.886 RETRACEMENT.
  • BC PROJECTION MUST NOT INCREASE 618 TO FORM D.
  • THE D POINT FORMS AT THE 0.786 RETRACEMENT OF XA.
  • EQUIVALENT AB=CD PATTERN IS MOST COMMON.
  • POINT D IS THE PRZ OR POTENTIAL REVERSAL ZONE WHERE BC PROJECTION AND 786 RETRACEMENT OF XA OVERLAPS.

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TRADING THE GARTLEY PATTERN

  • PRZ (D POINT) IS THE BUYING OR (SELLING) ZONE.
  • STOP LOSS IS THE LOW OR (HIGH) OF X.
  • PROFIT TARGET
  • TARGET 1= 2%-61.8% RETRACEMENT OF CD
  • TARGET2= 8% RETRACEMENT OF AD
  • TARGET 3= PROJECTED XA DISTANCE FROM THE PRZ LEVEL AT D

BULLISH  GARTLEY  IN  YESBANK  DAILY CHART

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BEARISH  GARTLEY  IN  M&M DAILY CHART
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CRAB PATTERN

The Harmonic Pattern CRAB is identified by its long stretching swing points. In this pattern, the PROFIT REVERSAL ZONE or the PRZ level at swing point D is overstretched and shoots beyond the initial swing point X.
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CHARACTERISTICS  OF  CRAB  PATTERN

  • AB LEG CAN RETRACE BETWEEN 382 TO 0.618 OF XA LEG.
  • BC LEG CAN RETRACE BETWEEN 382 TO 0.886 OF AB LEG.
  • BC PROJECTION SHOULD BE BETWEEN 24 TO 3.618 TO FORM D.
  • CD IS AN EXTENSION OF UPTO 618 OF XA LEG.
  • POINT D IS THE PRZ OR POTENTIAL REVERSAL ZONE WHERE AN EXTREME PROJECTION OF THE BC LEG AND 618 OF XA LEG OVERLAPS.

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TRADING  THE  CRAB  PATTERN

  • PRZ (D POINT) IS THE BUYING OR (SELLING) ZONE.
  • EXIT IF PRICE CLOSES BELOW OR (ABOVE) THE LOW OR (HIGH) OF POINT D
  • PROFIT TARGET
  • TARGET 1 = 2% RETRACEMENT OF CD
  • TARGET 2 = 8% RETRACEMENT OF CD

BULLISH  CRAB  IN  NIFTY DAILY CHART
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DEEP CRAB PATTERN

The critical aspect of DEEP CRAB pattern is the tight Potential Reversal Zone created by the 1.618 of the XA leg and an extreme projection of the BC leg but employs a 0.886 retracement of XA leg at the B point. The pattern requires a very small stop loss and usually volatile price action in the Potential Reversal Zone.

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CHARACTERISTICS OF DEEP CRAB PATTERN

  • AB LEG SHOULD RETRACE UPTO 886 OF XA LEG.
  • BC LEG CAN RETRACE BETWEEN 382 TO 0.886 OF AB LEG.
  • BC PROJECTION SHOULD BE BETWEEN 618 TO 3.618 TO FORM D.
  • CD IS AN EXTENSION OF UPTO 618 OF XA LEG.
  • POINT D IS THE PRZ OR POTENTIAL REVERSAL ZONE WHERE AN EXTREME PROJECTION OF THE BC LEG AND 618 OF XA LEG OVERLAPS.

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TRADING  THE DEEP CRAB  PATTERN

  • PRZ (D POINT) IS THE BUYING OR (SELLING) ZONE.
  • EXIT IF PRICE CLOSES BELOW OR (ABOVE) THE LOW OR (HIGH) OF POINT D
  • PROFIT TARGET
  • TARGET 1 = 2% RETRACEMENT OF CD
  • TARGET 2 = 8% RETRACEMENT OF CD

BUTTERFLY PATTERN

2627

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THE BUTTERFLY PATTERN IS A VERY PRECISE PATTERN WHICH FOCUSES ON FINDING REVERSALS AT NEW LOWS (BULLISH) OR NEW HIGHS (BEARISH). IT IS A FOUR-LEGGED PATTERN, VIZ, XA, AB, BC AND CD. THE POINT D IS A NEW HIGH OR LOW AND A POTENTIAL REVERSAL POINT IF THE FIBONACCI FIGURES ALIGNS WITH THE STRUCTURE.

The Butterfly is a specific 5-point extension structure that possesses a distinct alignment of Fibonacci ratios to validate the pattern. The primary determining element of the pattern is a precise 0.786 B point retracement of the XA leg. The Butterfly utilizes only a 1.27 XA projection as the most critical number in the PRZ. Furthermore, the equivalent AB=CD pattern serves as a minimum requirement for the pattern’s completion. But, the Alternate 1.27 AB=CD pattern is more common to the structure. The BC projection is another defining element of the pattern, as it must be at least a 1.618 extension.

BUTTERFLY PATTERN BASICS

  • Minimum AB=CD completion with Alternate 1.27 AB=CD pattern most common.
  • C point retracement can vary between a 0.382 to a 0.886, although 0.618 is
  • BC projection can vary from 1.13 to 3.618 and depends upon the C point
  • Alternate AB=CD patterns are common within the structure.

THE IDEAL BUTTERFLY PATTERN ELEMENTS

  • Precise 78.6% B point retracement of XA leg.
  • BC projection must be at least a 1.618.
  • Equivalent AB=CD pattern is a minimum requirement, but the Alternate 1.27 AB=CD
    is the most common.
  • 27 XA projection most critical number in the Potential Reversal Zone (PRZ).
  • No 1.618 XA
  • C point within the range of 0.382–0.886 retracements.

 THE PERFECT BUTTERFLY PATTERN ELEMENTS

  • Exact 0.786 B point retracement of the XA leg.
  • 27 XA projection exclusively.
  • 618 BC projection.
  • Alternate 1.27 AB=CD in the PRZ.
  • C point with a range between 50 to 0.886 retracement.

TRADING THE BUTTERFLY PATTERN

  • THE BUTTERFLY PATTERN IS DEPENDENT UPON THE PRECISE 78.6% RETRACEMENT  AND THE 127% RECIPROCAL RATIO AND IT ACTS AS A VERY STRONG SUPPORT AND RESISTANCE ZONES.
  • THE POTENTIAL REVERSAL ZONE D IS THE BUYING OR SELLING ZONE.
  • THE PROFIT TARGET IS GENERALLY THE ENTIRE XA LEG OR CD LEG OF THE PATTERN.
  • THE STOPLOSS SHOULD BE THE 161.8% OF XA LEG.

BEARISH BUTTERFLY PATTERN IN BHEL ON DAILY PRICE CHART

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BULLISH BUTTERFLY PATTERN IN HINDALCO DAILY PRICE CHART

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SHARK  PATTERN

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THE SHARK PATTERN IS A 4-LEG PATTERN AND IS DEPENDANT UPON THE POWERFUL 88.6% RETRACEMENT AND THE 113% RECIPROCAL RATIO. IT IS DENOTED BY O, X, A, B & C RESPECTIVELY. THE RETRACEMENT OF AB SHOULD BE BETWEEN 113% AND 161.8% OF XA. THE PROJECTION OF BC SHOULD BE 161.8% TO 224% OF AB. THE POTENTIAL REVERSAL ZONE C IS THE ZONE WHICH IS THE  OVERLAPPING  POINT OF BC PROJECTION AND 88.6% RETRACEMENT OR 113% RECIPROCAL RATIO OF OX.

SHARK PATTERN BASICS

  • DIFFERENT FROM THE M-TYPE AND W-TYPE ALIGNMENTS IN OTHER PATTERNS BUT THE SAME HARMONIC TRADING PRINCIPLES APPLY.
  • COMPRISED OF TWO INDEPENDENT PRICE SEGMENTS ­–
  • FAILED HARMONIC IMPULSE WAVE.
  • EXTREME HARMONIC IMPULSE WAVE.
  • POSSESSES DEFINED PROFIT TARGET.
  • REQUIRES ACTIVE MANAGEMENT.
  • POSSESSES PRECISE RATIOS TO DEFINE THE SUPPORT/RESISTANCE ZONE.
  • AS EFFECTIVE AS OTHER HARMONIC PATTERNS.

TRADING THE SHARK PATTERN

  • THE SHARK PATTERN IS DEPENDENT UPON THE POWERFUL 88.6% RETRACEMENT AND THE 113% RECIPROCAL RATIO AND IT ACTS AS A VERY STRONG SUPPORT AND RESISTANCE ZONES.
  • THE POTENTIAL REVERSAL ZONE C IS THE BUYING OR SELLING ZONE.
  • THE PROFIT TARGET IS GENERALLY 38.2% TO 61.8% OF BC LEG OF THE PATTERN.
  • THE STOPLOSS SHOULD BE THE HIGH OR LOW POINT OF THAT PARTICULAR LEG.

 BEARISH SHARK IN SBIN MONTHLY CHART
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THREE DIVES PATTERN
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The Three Dives pattern is a reversal pattern characterised by a series of higher highs or lower lows that complete at a 127% or 161.8% Fibonacci extension. This pattern offers the most precise entry point with the greatest profit potential. This will either be a 127% or 161.8% Fibonacci extension. The stop loss should be placed below the 161.8% Fibonacci extension level of the second dive. A simple way of finding a profit target is by drawing a Fibonacci retracement from the very high of the start of the pattern to the very low of the pattern, where the pattern completes the third dive. The take profit is the 61.8% Fibonacci level of this swing.

BULLISH 3 DIVE SHARK IN SBIN MONTHLY CHART
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Interested in learning from Market Expert Vishal Dalvi himself? – Register for our in-depth course on Harmonic Patterns in Trading.

Expert Seminar on ‘Technical Analysis’ by Vishal Dalvi at NL Dalmia Institute of Management & Research

Mumbai, Maharashtra, February 18, 2016– With growing number of management students looking for opportunities in trading, very few can tap the benefits of advanced trading techniques in India. Understanding this gap in educating the students in right way, NL Dalmia Institute of Management Studies & Research, organizes a fast-paced Management Development Program (MDP) every year.

And this year, Technical Analysis expert from Waves Research Advisory & Pvt. Ltd., Mr. Vishal Dalvi, is conducting a seminar at the institute on February 27th & 28th.

Trading with advanced techniques like Technical analysis can provide students a much needed edge over the competition and help them get acquainted with the concepts like – Dow theory, Candlesticks patterns, Moving averages, Trend lines & channels, Classical price patterns-Rectangle, Types of charts, Fibonacci Retracements & projections, Elliot Wave Principle and much more.

“Stock Markets movements are dynamic & Trading /Investing is ever challenging task where rational Valuations are taken over by Emotions and Psychology of the Market participants. With the current Global Markets volatility and Risk, the need for assessing sentiments and Inter-Markets Analysis becomes even more important. Fundamentals of individual companies are sometimes taken over by Fund Flows, Macros and Sentiments. In such times Technical Analysis helps to gauge and monitor the Demand supply equations of the Market and forecast much accurately.We have planned to give the participants better insight into timing of market for short term trading and long term investing. . ” said, Vishal Dalvi, CMT & Founder at Waves Research & Advisory.

NL Dalmia Institute of Management Research & Studies, has planned this event all over the February & March 2016, where tutors from variety of fields will equip students with training in Technical Analysis, Derivatives & Risk Management, Fixed Income & Money Markets of India & ‘Innovation & Creativity’.

The registration for the Seminar on Technical Analysis has already begun, and student can register for the event or find out more information here-http://wavesresearch.com/mdp-seminar/

Combining Harmonic Patterns With Elliott Wave Principle For Trading

In my last article titled “Elliott Wave Principle – An obsessive Forecasting technique, is it an effective Trading Technique?” which argued that even though Elliott Wave is a reasonably OK theory to forecast prices it is not necessarily a good trading tool. I mentioned a technique using RSI indicator how one can do reverse counting and trade better. In this article I will present you another technique which can be used along with the Elliott Wave Principle to make Trades Executions and not just forecast.

So getting straight to the point let me ask you 2 questions

  • Which is the best wave to trade within the Basic 5-3 Elliott wave pattern?

The answer is pretty obvious and very well known that ‘wave 3’ is what we all want to ride. Because that is usually the longest wave; clearly identifiable; Dow Theory Higher High confirmation occurs; Momentum is strong with possible breakout gap.

Having answered this, it bring us to the next question.

  • Where should I enter to trade the wave 3?

This is where it gets really interesting. Traditional Elliott Wave Principle only confirms a start of wave 3, when the high of wave 1 is taken out. So theoretical answer is “Enter on break of high of wave 1 with a Stop Loss of low of wave 2 with projection targets (1.618/2.618 of wave 1) for wave 3”. Conceptually it sounds ok and the Risk Reward picture also looks good and one can do it if either you are trading futures on lower time frames (15/30/60 mins) or if you are buying stock in CASH and holding it for months or year. There you can follow this “Stop loss of low of wave 2” thing. But for someone like me who trade futures on Daily/Weekly charts, waiting till the low of wave 2 breaks it significant Capital Risk along with mental torture. Leave aside the possibility that the wave 3 which you are assuming is just a ‘wave c’ of a three wave up move and prices will eventually collapse even below your low of wave 1; there the frustration is even more.

That makes one think of other ways to enter to play the way 3. Wishfully we would want to enter at the Low of wave 2, wouldn’t we? Yes and fortunately there are few ways of achieving that. There are 3 harmonic patterns which are able to help us initiate Buy or Sell trades right at the end of wave 2 and start of wave 3.

harmonic wave 1

These 3 Harmonic Patterns are

  • AB=CD
  • BAT
  • GARTLEY

1. AB=CD

This is basically a Zig-Zag (A-B-C) pattern from Elliott Wave. But Elliott only says that in a Zig-Zag

  • Wave B does not go above start of wave A
  • Wave C goes below end of wave A
  • C is usually equal to A

But Harmonic Pattern defines the point D as the “Potential Reversal Zone” (PRZ) where you should be buying. The naming convention for harmonic is different than from Elliott wave and should not be confused with each other.

This point D needs 3 conditions to be fulfilled.

  • BC is retraced 61.8- 78.6% of wave AB (For Elliott, this means Wave B should retrace wave A by 61.8-78.6%)
  • Length of AB=CD ( For Elliott , this means Wave C = Wave A)
  • Length of CD is between 1.27-1.618 times projection of BC. Now this is the unorthodox part and Elliott has no reference or any relation of wave B with wave C.

What these 3 conditions together ensure is that the PRZ point D is a precise definable area for a reversal Buy trade.

This harmonic PRZ point D corresponds to the end of wave C/ (2) where one is buying in anticipation of the upside wave (3). Elliott helps in identifying the overall structure. If you see a AB=CD pattern preceded by a 5 wave impulse you know that the completion of the correction will result in a bigger impulsive move higher.

harmonic wave 2

harmonic wave 3

harmonic wave 4

2. BAT

The Bat pattern is a replica of the 5-3 pattern of Elliott wave. harmonic wave 5

XA= WAVE 1

AB= WAVE A

BC = WAVE B

CD = WAVE C

 

Again what we can see is that the ‘D’ point is a precisely definable point which says D is retracing 88.6% of wave XA. Meaning wave (2) retracing 88.6% retracement of wave(1). harmonic wave 6The Elliott Wave Principle makes no reference to this retracement level of 88.6% and you will be astonished the number of times Market respects this level. What is important that it also satisfy the rule of Elliott Wave that wave (2) cannot go below the start wave of wave (1), which also implies it can retrace wave (1) even by 99%.

The beauty of this pattern is the the kind of Risk Reward ratio it offers. Your stop loss is either point D or X and it offers a reward of a move above A, which is huge.

harmonic wave 7

3. GARTLEY

The Gartey pattern is a different version of the 5-3 pattern of Elliott wave. The difference in the Gartley and Bat is the retracements of AB and CD.harmonic wave 8

Understand that if you look at AB, BC, CD these 3 waves together is a clear 3 wave Zig-Zag. What is important is that your first wave XA should be impulsive in nature. And you don’t really need to see internal waves, but a swift up move without any overlapping correction is enough to be identified as an impulse. harmonic wave 9

Once you have the impulse up move followed by the 3 wave zig-zag, just match the Fibonacci combinations to arrive at the Harmonic pattern and wait patiently for the point D to initiate the reversal Buy Trade.

 

 

 

harmonic wave 10harmonic wave 11Risk Management

Once the pattern is made and you get a reversal from D point. Stop loss could be close below low of point D for a Risk Averse trader. A better technical stop loss is the point X, which is like the low of wave 1. More important is at what point you take profits. Understand that these Harmonic Patterns are probabilistic trade set ups and the success ratio of these patterns will come somewhere around 70% as per my experience. Let me tell you where many traders can falter. After seeing a pattern one starts expecting that implication of the pattern is a break above A, since if there has to be a wave(3) that has to eventually go above wave (1). But understand this. What is your Risk when you are buying at the point D? Difference between point X and D, right; which is very small. So the way I trade is the moment I am ‘in the money’ twice or thrice of the initial Risk taken at point D, I am happy to book it. After that let it even go above wave (1) it doesn’t bother me. Since that’s the trade set up I am playing. The target are 38.2%, 61.8% retracement of the fall AD; which most of the times coincides with 2-3 times of initial Risk at point D. Of course there are various different position sizing strategies if you trade with multiple quantities, but the point I am trying to drive home is that not always you will get a move above (1). So keep taking some profits home.

There are several other Harmonic patterns which can be clubbed along with Elliott Wave Principle to get trade set ups, the above listed are just few of which are in line with the Basic Elliott 5-3 pattern. Remember Elliott Wave Principle was just created to describe the Market structure but when used along with Harmonic Patterns it makes it a Tradable concept. Harmonic Patterns can be traded without understanding of Elliott Wave also, but when you know the Wave Count and the broader structure of the Market you have way more edge than just trading the Harmonic Patterns.

Interested in learning to trade with Harmonic Patterns with Elliott Wave Principle? – We are offering one of a kind training course in India. Know More!

Elliott Wave Principle – An Obsessive Forecasting Technique; May Turn Into A Destructive Trading Technique!

The title raises the question ‘Isn’t good Forecasting coherent with good Trading’? The answer is “NO”.

Trading and making money out of Trading is a far different ball game from just Forecasting. Even if someone was to exactly predict the highs and lows of the next intermediate move for Markets in next week, I cannot guarantee he or she will make money for sure.

Coming to Elliott Wave Principle, It is the only Technical Analysis technique that can give you a “Long Term Perspective” which opposes the general misunderstanding of people that Technical Analysis can only be used in the short term. All other Technical Analysis tools have limitations to their forecasting ability. Like any classical patterns like Head &Shoulders, Rectangle, Flag etc. can be used until their targets are achieved. Once the targets are done these patterns cannot be used to predict or foresee the next price action. Similarly Momentum Indicators like RSI, MACD etc. are price following and gauge the momentum or how much overbought/oversold marketsare, but lack forecasting ability.

elliott wave principleWith Elliott Wave Principle once you know where you stand in the pattern you are able to forecast all possible up and down moves in the future. Also since the pattern has a “Fractal Nature”, you can forecast moves with the time horizon right from 1 minute to 1 Decade.

Personally, Let me state it that I have been a strong propagator of this theory and have been using for more than 7 years now for Trading. Only difference is that amount of usage of this theory in my Trading has been reducing every year while my Trading P&L has been on a growing path. Not because it is any less significant theory now, but because I accepted the limitations of the theory and have been able to Stick to only few important rules & concept of the theory and combine it with other important Technical Analysis tools for finding Better Trade Setups which I will explain later. What I am focusing in this article is how Elliott Wave Principle if used wrongly can hamper your trading.

Here are few points to ponder over for the Hard Core Elliotticans.

1. It was never a “Trading Technique” in the first place.

When Mr.R.N.Elliott in around 1930s discovered this theory, he was just proposing how Market prices unfold in a specific pattern, he never said you should “Buy” or “Sell” here. It was a good explanation to how Market participant’s behavior was repetitive in nature which caused prices to follow certain pattern the same way in different time frames. A simple analysis of ‘Impulse’ and ‘Corrective’ moves can help us identify the larger direction of the Market. It was later on that people started to use the Theory as a Trading Methodology.

2. The ‘Alternate Wave Count’ Gimmick

Mr. R.N.Elliott was very smart. He devised a theory which will be always “RIGHT” irrespective where the Markets eventually goes. On a particular stock or Index, there are at least 2 and almost 7 to 10 different wave counts possible. So there is at least one “Bullish Alternate” and at least one “Bearish Alternate”. So at any juncture you decide and prefer to stick and go ahead with the Bullish Wave Count and Buy the stock and suppose the Market went against you and fell you will lose money, but has the theory gone wrong? Not at all! It clearly had suggested that there was an “ALTERNATE WAVE COUNT GIMMICK” which was bearish. So if I combine all possible 7 to 10 wave counts together, some counts will say Markets will go up, some counts will say Markets will go down and some might say it will be stuck in a range. That’s great Information! Markets may go UP, DOWN or Sideways. Wow!

3. The 5th Wave is Near Completion.

Take someone who has just recently read Elliott Wave Principle and show him a chart in which some rally is seen. Invariably he/she will try to fit 5 waves up in that rally and say the “We are completing 5thwave and now should start a correction”. Here is a classic example of 2009-2010 rally in Sensex.

Elliotte-Wave-Principle-1

4. Even the Perfect textbook Impulse can get fully retraced.

Once you see a nice looking impulse move downeven if it’s a corrective fall, then after one correction up move which should not break the high of the impulse move down we should have a new low made. But there are series of examples in past where impulsive up moves and down moves are fully retraced without completing the pattern.

SILVER SPOT

Elliotte-Wave-Principle-2

 

DOW JONES INDUSTRIAL AVERAGE (DJIA)

Elliotte-Wave-Principle-3

In 2008, when I had got just introduced to this theory of Elliott Wave Principle, I had read that Robert Prechter, the one who introduced to all of us this theory, predicts Dow Jones to go to 500 while it was in the  9000-10000 range. I am very grateful to Mr. Prechter for teaching us this beautiful theory, but with all due respect the Markets have gone up almost more than 2 times from the 2009 lows. Oh yes, of course, the Theory has kept provision like Irregular B, Irregular or Expanded flat which are able to justify such moves after they have taken place. As I said, “The Theory is always right, irrespective where the Market goes.”

5. Creating a strong bias on a Market

Few perfect set ups can also be violated as shown above and having a Bias on a certain wave count is the most fatal thing you can do while Trading using Elliott Wave Principle. Especially when you are taking reversal trades, if Markets shoots the other side you could miss the entire next move. These are the times you have to be ready to be flexible and use other tools to gauge the Market direction.

6. A 5 wave move can also be counted as a 3 wave move

The crux of the Elliott Wave Principle lies in identifying whether the current move is 5 wave impulse or a 3 wave corrective move. But it is funny that the same move once we marked as a 5 wave impulse can later be marked as a 3 wave corrective move just to adjust a particular wave count. Your bias on the Market can force you to count a certain move in a way that it satisfies and confirms with your Market view.

Elliotte-Wave-Principle-4

Though the theory has few drawbacks it still remains one of the best techniques to Identify the Market structure and direction.

If you are trying to use the theory for Trading it has to be understood and accepted that there are limitations and Trades set up have to be found in combination of other indicators like RSI, Fibonacci etc. If you are just into research and if you find it fascinating to put some numbers and wave counts on chart you can play around but if you want to make some money using the theory know that you cannot use it alone. 

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Traders Vs. Research Analysts – 6 Differences You Must Know!

I have met so many good Technical or even good Fundamental research analysts in India, who do fairly well at their job and are good at Forecasting markets, but when it comes to Trading and putting their own money at stake invariably they fail miserably. Following are some of my observations which differentiate a Research Analyst with a Trader.

Traders Vs. Research Analysts – 6 Major Differences 

No Matter Where Markets Goes, Research Analysts Are Always Right!

Take this as an example a view from a Research Analysts. “Nifty stands at a very crucial juncture now. A decisive break above 8350 levels will take nifty towards higher levels of 8500-8600. Crucial support will be seen near 8300-8280 region if prices sustain below this zone expect further sell off towards 8000 levels.”

So whether the market goes to 8500 or 8000, after few days this guy will be right as per his analysis. Funny part is they can always get away with these words like “if sustain”, “decisive”, “Closing basis”.

A trader can have no Marketing, presentation gimmick. Bottom-line for a trader is a Positive P&L statement.

Research Analysts have a serious “Maine bola tha na” disease.

Not only a Research analyst go right irrespective where the Market goes, they will come back and make this irritating statement with a boosting confidence “ Dekha, Maine bola tha na”  (See, I told you so!)

Traders Vs Research Analysts

Risk Takers

Traders by default are risk takers. They know that to make good money, you got to take Risk. More importantly they know how to manage and mitigate Risk as well. Risk management is given equal importance as Forecasting.

Execution

Consider a research analyst that makes a forecast for Next week that Market will be a rally to point A then fall to B and then again rally to point C. If next week Markets follows his/her forecast exactly point to point, Still I CANNOT GUARANTEE he/she would have made money out of it.

Why? Seldom poor execution at the time when Markets are live is a key differentiator. Should I buy/sell now? Should I wait? What if I get a better level?

A trader has an ability to hit that BUTTON when he wants to get in or out of the Market.

Taking/Cutting Losses

“How can I go wrong? I am THE analysts”….says the Research Analysts

“Let me get out of this loss trade before it gets bigger, I will make it up somewhere else”….says the Trader.

A good trader leaves his Ego back home when he comes to the Market.

Stability

There has to be something in favor of the Analysts. They have a secured stable Life. Traders may go through the tough dry spells without any profits which is the most challenging part.

I have nothing against the Research Analysts, but being a Full-time trader I have seen several research guys not doing well at trading. Of course, there may be several Research Analysts who may also have mastered the art of Trading. If only they could focus on the Risk Management and psychology each Research Analysts have the ability to become a great trader.

This re-emphasize that Forecasting is only 20% Technical/Fundamental Analysis, 40% Risk Management, and 40% psychology and Emotion Handling.

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Just Finished Your Course In Trading? – 9 Tips For Trading on Day 1!

I have worked and consulted with number of first time traders over my years of experience, and for the most of them, the results were outright disappointing. Their thrill and excitement for real time trading ended with ‘The Day 1’!

The perception about trading smoked out into the thin air f you don’t think through. Sure you might have done every step by the book, and you use the awesome tools exactly as your trading coach have suggested. What went wrong then?

Let me give you ‘Quick 9 Tips for market trading on Day 1’, if you have faced the same disastrous day 1, or if you are a bit smarter and reading this just before getting your hands on trading!

 1. Trade SETUPS, not Markets

Always remember that you don’t trade stocks, commodities or currencies, you trade SET UPS. Many traders get hung up on a particular stock if they lose in it and try to recover the loss from the same stock. Keep your ego aside; opportunities are floating across the Markets every day. Prepare your few Trading Setups which suit you and follow them religiously. Don’t Trade Randomly.

2. Capital is the King.

“Sar salaam toh paghadi pacchas”.If your Trading capital is not depleted, there is always tomorrow. Simplest way of making sure your capital does not evaporate is decide a % of capital stop for each trade.

3. Time Frame for Trading

Whatever Time Frame you are trading always confirm the trend on the Time frame one degree higher.

4. Exit Strategy.

If you do not have a strategy for Exit for your Trades, Stop trading altogether.  Getting into a trade is the easiest thing in the World. You could just flip a coin and enter a Trade. What differentiates a good and a bad trader are ‘EXITS’!

9-tips-for-trading-on-day-1

5. Risk Management is a nice word; well misunderstood.

No. Risk Management is not just putting a Stop loss for each trade. Risk Management is the Statistical understanding of the relation between“Success Ratio” vis-à-vis “Risk Reward Ratio” for all your trades. Monitor these 3 ratios to understand why your P&L statement is performing the way it is – Average Profit per Profitable Trade, Average Loss per Loss Making Trade, Success Ratio of Trades.

6. Good Execution comes from Clarity on Trading Plan.

Think of this – You do research for hours over the weekend and finally arrive at the stock you would trade next week. The Analysis you do is on Daily Chart and after you enter into the Trade, one sudden jerk in the Market on 15 min, hourly chart and you suddenly Panic and Exit the trade, only to watch the stock go in favor eventually after few days.

How many times must this have happen to you?

Good execution happens only if while entering the trade you have planned when exactly you will Exit or Take your Profits in your trade. No matter how good Research you do, Execution in Live Markets is what differentiates a Trader to a Research Analyst.

7. Train Your MIND

Your MIND makes a lot of difference than you think it does. Your attitude, Frame of Mind, Breathing Style, and Thoughts make a lot of difference on your Trading P&L. Many Traders do not realize the power of Mind to achieve Trading Success. A series of bad trades affect the psychology of a Trader and makes him/her vulnerable to low confidence and self-doubt. Self-belief and the positive attitude can take you places with the right Trading Strategies with good Risk Management methods.

8. One Trend Following System is a Must.

If you plan to get into Trading Full Time, you will have to develop at least 1 Trend Following Trading System for you to be in the Market objectively which every side it goes irrespective for your personal judgment or View.

It helps in  developing a consistent, Stress-free Long-term capital appreciation.

9. Keep Yearly, Monthly, Weekly Targets

A trader without any well thought Trading Targets is like a Gambler in a casino just to enjoy the thrill of Speculation. Trading Targets help you plan your Risk and Trades very well. Set Long Term Goals and work reverse way to jot down till your weekly, daily targets.

If you are making less than 18% compounded annual returns, better leave Trading and lend your money at 18% per annum to someone or invest our money in Index Fund regularly and do something else instead; it’s not worth the time you will devote, the Stress and the Risk you taketrading the Markets.