Secrets to Predicting Market Direction

Tren Tra ng In c ator s ket and more new money is ow-

IdENTIFyINg OPPOrTUNITy

ing into the market. This reects

This informaon can be used to

why the price increases.

idenfy an opportunity when

Of course, the exact opposite

there is a major top or boom in

is true on a declining market.

the futures markets. If you are a

Charsts combine both the price

stock trader, you may also want to

movement and the data from vol-

pay aenon to this data, espe-

ume and open interest to evalu-

cially if you are trading high beta,

ate the “condion” of the mar-

or stocks highly correlated to

ket. If there is a price increase on

underlying commodity markets.

strong volume and open interest

For example, in the graph in Figure

increases, then this is a signal that

8.2, we have a daily chart on corn

there could be a connued trend

futures. There are several compa-

advance. The opposite is true for a

nies that come to mind that have

bear market when prices decline.

a vested interest in what happens

If price increases, increases, volume stays

to the trend in corn prices; one is

relavely at or is lile changed,

Archer Daniels Midland (ADM) and

and open interest declines, this

another is Bunge (BG).

reects a weakening weakening market con-

A good queson to ask would be:

dion. This is considered to be a

can higher corn prices help or hurt

bearish situaon because if open

a company’s boom line? To a

OPEN INTErEST

short, and for every buyer there is

interest is declining and prices are

a seller. The open interest gure

stock trader, it would be important

On the other hand, open inter-

rising, then this shows that shorts

represents the longs or shorts, but

on a price advance to ascertain

est reveals the total amount of 

are covering by buying back their

not the total of both. So the gener-

if the move was sustainable and

open posions that are outstand-

posions rather than new longs

al theory for open interest is that

accompanied by widespread accu-

ing in existence and not oset or

entering the market. That would

when prices rise and open interest

mulaon, rather than a short lived

delivered upon. Remember that in

give a trader a clue that there is a

increases, this reveals that more

price spike. Here is where volume

futures trading, this is a zero sum

potenal trend reversal coming.

and open interest would help one

game. For every long there is a

new longs have entered the mar-

gather further evidence.

Tren Tra ng In c ator s

Noce in Figure 8.3, we have three

price advance, accompanied with a

there could be a sustainable sustainable price

Hecla Mining (HL). Now whether

separate panes. The top secon

rise in open interest, revealing that

advance over me.

you are a futures trader or a stock

is a candlesck, the middle is the

traders are adding to longs with

open interest data, and the bot-

an increase in trading volume. This

tom secon is a volume histogram

indicates that traders are accu-

with a 20-day moving average

mulang posions and that the

study overlaid on the bar graph.

health of this trend is very strong.

From late June of 2010, we see the

This helps one to understand that

Let’s examine the graph in Figure 8.3 further. Gold can be traded as a futures contract, or stock traders can trade an exchange traded fund (GLD), (GLD), or highly correlated stocks such as Newmont Mining (NEM) or

trader, here is where volume and open interest analysis can help traders understand the overall health of the trend. This informaon may help traders stay with the trend a bit longer. Like the

Tren Tra ng In c ator s old saying goes, “ride the winners and cut your losses,” using these technical tools may help you to see if the price advance or the trend is sustainable. As the chart shows, once again as prices start to boom in late July of 2010, the open interest gures shown in the middle secon start to increase. This is also accompanied by an increase in volume. Together, this signals that the start of the new bullish trend is healthy and sustainable.

CONCLUSION There are many indicators that rely and are

QUICk QUIz 1. volume is an inicato of te ealt of a maet ten. a. True b. False 2. If olume is inceasin in a isin pice enionment, ten: a. b. c. .

The market is in a bullish mode The market is in a bearish mode Further price appreciaon can be expected Both a & c

3. deceasin olume in a weae weae pice enionment:

built based upon prices, but very few are derived using volume studies, and as far as commodies are concerned, the open interest data. Both tools are instrumental for the traders who want to stay on the right side of the trend and are easy to access. Remember, these tools help conrm the overall health of the market trend.

a. b. c. .

Indicates a plateau. Can be used to predict a reversal. Could be a sign of a future downtrend. Indicates a bear market.

4. Wen pices ise an open inteest inceases:

9

Trend Lines TrENd LINE ANALySIS

I

was taught nearly 30 years ago, the most protable way to trade is with the trend. So naturally, it’s impor-

tant to idenfy what the trend is and in what market condion you are trading. Unfortunately, many people do not adhere to this advice, either by trying to outsmart

the market or leng their intelligence intelligence or ego interfere with a simple raonale of  idenfying the current market condion. In this chapter, I will disclose some of the more proper methods for idenfying the market condion, or what we call the trend, by simple line drawing techniques

a. b. c. .

New longs have entered the market. New shorts have entered the market. Money is owing out of the market. Traders Traders are taking prots. Fo te answes to tis qui, o to TaesLiba.com/TLEcone.. TaesLiba.com/TLEcone

and ways to help idenfy when a market trend is potenally exhausng itself  or running out of steam. I will also show some of the techniques that I learned early in my career on how to correctly use trend line analysis to help me implement trades. Most importantly, based on these techniques, I will cover how to look for

Tren Tra ng In c ator s inial entry points of interest, stop placement levels, spots to add on

FIrST ThINgS FIrST

posions once a trend is maturing, and places to move protecve stop

I was always taught if you are going to analyze the market, you need to

orders based on the use of drawing lines on my charts.

gure out where prices can go. To do that requires you to look at where

Throughout the history of the trading industry, many phrases and cli-

prices have been. Start with looking at the longer-term picture. Drop

chés have evolved due to past human errors and successes. From my

down to the intermediate term and then to the short-term me frame.

30-plus year career, I would like to share with you some of the tech-

For longer-term invesng invesng requiring more than one month, I will start

niques and taccs for successful trend trading based on some of those

with the monthly chart. Drop down to a weekly chart and use my daily

phrases.

or end-of-day charts. For swing trading, I will sll look at the weekly and daily me frames, but include a 60-minute chart. For day traders, I like

ThE TOP FIvE SECrETS TO rEMEMBEr WhEN TrENd TrAdINg 1. The trend is your friend. 2. The trend is your friend unl it ends. 3. Never ancipate when a new trend will begin; markets have a habit of 

moving further than traders expect. 4. When in a bullish trend, buy pullbacks. 5. When in a bearish trend, sell rallies.

to look at the weekly and daily market direcon and then take trades based o of the 5- and 15-minute me frame. As for drawing trend lines, the important thing here is to idenfy the pivotal swing points, both highs and lows, and then extend a line out to help idenfy the trend’s direcon. Let’s examine Figure 9.1. This is a chart on Potash (POT). I have purposefully made a black and white chart so that if you print this page out, it will be seen clearly. From the low marked point “A,” which was created by a “W” boom paern as the right side low was formed by a hammer candlesck, the market moved up to the rst pullback low, or swing low. This is where we would con-

In this chapter, we will go over the proper techniques for drawing trend

nect the trend line and extend out in the future. As the saying goes,

lines such as lines drawn from lows, from highs, and from range mid-

“the trend is your friend unl it ends.” Here is how correctly drawing

points. We will discuss the importance of the condion and locaon of 

trend lines can help you idenfy a change in a trend’s direcon.

those trend lines specically, the angle, degree, and separaon from price to the trend line.

Once prices have traded beneath the longer term extension, say for two consecuve closes below the trend line, one can argue that the trend has changed direcon. Aer the peak at point “B,” the trend started to

 Iff you  I you ar aree goi going ng to an anal alyz yzee the the mar marke kett, you you need to gure out where prices can go.

reverse and change direcon. So does one look to buy the pullback as prices start to close back in on the line extension? If one did not enter at the beginning phase of this “W” boom paern, then one could look for

Tren Tra ng In c ator s

a low risk trade setup by buying

small loss. As you can see, prices

Let’s examine the next graph in

towards this support line, that

a test of the trend line extension.

connued lower. Once a reversal

Figure 9.2; this is a weekly chart

would be a targeted area to look

However, once prices fail to con-

occurs, traders wait for “bounces”

on McDonald’s (MCD). Another

to enter a long posion. As we

nue higher and close beneath the

or rallies to sell against. One such

double boom forms, creang

say, this denes buying pullbacks

uptrend line; in other words, fail

rally occurs in early May as the

the “W” paern from point “A” to

in a bullish environment. Point “C”

to hold the trend line support, the

chart shows. To determine future

point “B.” If one wanted to draw

intersects right at the trend line

trader should exit the long posi-

overhead resistance, one would

a textbook upward sloping trend

extension. Noce that the candle

on. This would result in a loss,

draw a line against the high at

line, it would exist at a nearly 45

formaon is a bullish engulng

but as the example here shows, a

point “B” and extend out.

degree angle. Once prices retrace

paern, which may help to con-

Tren Tra ng In c ator s However, once prices break out and above that level, if the market is to prove itself to be bullish, prices should not trade back under that line. The line of old resistance should prove to become the new line of support. Instead of buying the market on the rst breakout of old resistance, most conservave traders will wait unl the market pulls back to the horizontal line and then they will go long with close stops because the price acon should hold based on the theory that old resistance should act as new support. In this example, trend line “B” has acted under that old axiom.

QUICk QUIz 1. Pope ten line analsis can elp taes ienf: a. b. c. .

Inial entry points Stop placement levels Add-on posions All of the above

2. Wen in a bullis ten, bu pullbacs. a. True b. False 3. Wen in a beais ten, sell pullbacs. a. True b. False 4. A tae soul eit te lon posion:

rm the posive momentum as

support. Figure 9.3 helps to illus-

prices bounce o of the newly

trate this technique. In Figure 9.3,

constructed support trend line.

using the same weekly chart on

We have addressed how to properly idenfy bullish trend lines, one area that I believe is crical is idenfying what we say is “old resistance,” which turns into new

McDonalds (MCD), (MCD), you can see the old highs during 2008. If you draw a horizontal line across your chart as prices boom in 2009 and start the new uptrend, that old high is creang a ceiling of resistance.

a. As prices connue higher b. When prices close beneath the uptrend line c. When prices hold the trend line support . All of the above Fo te answes to tis qui, o to TaesLiba.com/TLEcone.. TaesLiba.com/TLEcone

Tren Tra ng In c ator s 10

Elliott Wave Theory 

N

o book on trends would

be complete without some introducon on the

Ellio wave theory. I do not necessarily use Ellio wave theory consistently in my trading, but I do know the principles of the waves and the theory behind the psychological aspects that drive human beings are reected in market prices, namely fear and greed. As it is oen stated, human emoon oen interferes with human intelligence. I want to share with you my experience, feelings, and observaons on this theory, as well as quote a good acquaintance who is one of the premier technicians in the world on the eecveness of  Ellio Wave, who says: “it works when it works.” This means that I do not use it all the me, and as

I disclose the principles here, you

and “M” top formaons, seasonal seasonal

thing that has been achieved and

will understand why. So I guess

analysis, pivot points, moving aver-

pracced even by Mr. Ellio him-

you are now asking yourself why

ages, trend lines, indicators like

self. His discoveries were simply a

bother sharing it in this book? The

ADX, MACD, and stochascs, and

compelling phenomenon into the

reason is because it reveals trends

volume and open interest studies.

art of forecasng price moves. I

and the trend paerns.

hISTOry ANd vALUE OF ELLIOTT WAvE

I believe it is important that traders have a complete understanding of trend analysis but also phases or waves as they are con-

will cover the basis for his discoveries and the overall strengths as well as weaknesses of his work. Keep in mind that Ellio wave is a fractal concept which works in

Ralph Nelson Ellio (1871-1948)

sidered. Ellio wave principles can

was a dedicated student of the

help you uncover just that, and

stock market. Back in the 1920s,

more specically, what phase or

he observed market moves, both

“wave” the market trend is in. As

bullish and bearish, occur in three

you may have already discovered,

disnct phases. He began to

all markets certainly do trade in

develop theories and views that

phases, from periods of consoli-

the overall prices in stock market

daons to trending modes. With

averages move in waves. This was

the knowledge of the Ellio wave

presumed to fall in line with the

principles, this informaon may

understanding of the work cred-

give you a beer understanding of 

A completed Ellio wave cycle

ited by Charles Dow as dened in

which side of the market to be on,

from bullish to bearish or bearish

the Dow Theory.

and to capture protable moves

to bullish consists of eight waves.

The purpose of this chapter is to

with surgical precision. And hope-

There are two disnct wave deni-

give an introducon as to what

fully more mes than not, trading

ons. Impulse waves are the ones

Ellio wave is and how you can

from the winning side.

termed to be moving with the

apply this method in the markets

Since many of the concepts

combined with what we have

explained already are great tools

already covered, incorporang

in and of themselves, combining

Impulse waves have ve primary

Dow Theory with “W” booms

them with Ellio wave is some-

price movements and the cor-

mulple me frames so that it can truly benet all styles of trading from day to swing to posion traders. The fractal concept is simply dened as cycles or paerns repeang in shorter me frames and developing in longer-term me periods, meaning there are waves within waves.

main trend and correcve waves are against the main trend.

Tren Tra ng In c ator s recve waves are seen as having

posed of eight price moves, ve

For more experienced charsts,

wave one count for the weekly

three primary price moves, which

up and three down, as you can see

they would of course recognize

me period. We can also see a ve

are leered and run in the oppo-

in Figure 10.1. Incidentally, three,

that the end of a bullish move’s

wave count on a ve minute chart

site direcon of the main trend.

ve, and eight are contained in

h point could possibly be con-

that composes just wave one on

A healthy long-term trend follows

the Fibonacci series of numbers.

sidered the number one point of 

a daily chart. Ellio wave theory

the indicaon of heavier volume

The fundamental concept behind

a one-two-three formaon, or the

combines the best of tradional

during the impulse waves (one,

Ellio’s Ellio’s theory is that bull markets

top of a head and shoulders for-

charng techniques and price pat-

three, and ve).

have a tendency to follow a basic

maon. The one thing Ellio most

tern formaons such as triangles

ve-wave advance, followed by

wanted charsts to recognize is

and wedges. These are simply con-

a three-wave decline. The exact

that his wave theory worked on

solidaon paerns within trends.

opposite is true for bear markets.

long-term charts as well as intra-

These trends’ phases are consid-

day charts.

ered waves.

It is assumed that Ellio used some of Fibonacci’s work because a complete wave cycle is com-

A WAvE IS A WAvE

Price objecves from predicting possible highs or lows can

It does not maer what me

be determined through the use

frame you trade in; a wave is a

of Fibonacci raos and the cor-

wave. The idea here is that each

responding rules associated with

wave is simply a subset of another

each wave descripon. I also have

wave just to a lesser degree. Each

had tremendous success iden-

wave is itself part of the higher

fying turning points as indicated

degree wave. We can dene

by the maturity of a price move.

this by saying waves of one me

For example, if it is the boom of 

frame can be expanded to relate

wave two or four, I may look for

to a higher me period, and one

support targets using the Fibonacci

me frame can be subdivided

raos as well as the pivot point

into a shorter term me frame.

support targets. When I see a

For example, we might see a ve

conuence or mulple cluster of 

wave count on a 60-minute chart

support targets from using both

that, when converted to a daily

techniques, it heightens my asser-

or weekly chart, counts as a full

on to go with a posion because

Tren Tra ng In c ator s I understand which direcon to

forms, Fibonacci correcon, and

The Ellio wave principle was

is referred to as a proporonate

trade from. I will admit there are

projecon raos and has a me

originally applied for the stock

and alternate relaonship with the

mes when an Ellio wave pat-

element as magnitudes of each

market, but the core foundaon

measurement of the waves.

tern is crystal clear and helps me

waves are concerned.

of its decipherable use was based on the premise of mass human

Wae One

psychology. Due to the exorbitant

The rst wave is the base or start-

extent of trading on a global scale

ing point derived from a con-

ysis can work with all markets

in foreign currency, I nd it works

solidaon trading phase aer a

well when the paerns jump out

prolonged price decline. It usually

on the charts. In a world of cha-

appears to be simply a small cor-

and time frames; whether it is stocks,

oc and turbulent volality, Ellio

recve bounce from a previous

wave aempts to give a trader

trend. It is the smallest in price

a beer chance of interpreng

moves as compared to the three

what phase a market is in, price

impulse waves. This stage or wave

objecves, and me duraons to

is what technicians have discov-

expect a move to last. It is highly

ered to be an accumulaon phase.

subjecve, and I strongly suggest

Using what we have learned with

scking to the rules I will outline

Fibonacci calculaons so far, we

Trading is not about being rigid

when applying these principles in

can apply the rao numbers to

and scking with just one sin-

your trading.

develop a technique to give price

trade on the winning side, and then there are mes when I do not have a clue and can not make out any clear or disnct paern. That is when I rely on other techniques such as trading in a short term me frame within the direcon of a higher degree me frame. For instance, if the 15-minute trend is up, classied by the market trading above a set of moving averages (namely pivot point aver-

 Elliott  Elli ott wave analanal-

 ETFs, futures,  ETFs, f utures, or  Forex.  For ex.

ages), then I look for buy signals as dened by a series of higher highs, higher lows, and higher closing highs as prices trade above a set of  moving averages on the ve-min-

gle method. Market condions

projecons for a typical ve wave

of tools to improve your market

rULES FOr TrAdINg WITh ELLIOTT WAvE

The key in understanding Ellio Ellio

forecasng abilies. Because it is

Each wave has its own set of char-

wave move, we can use several

wave is that it can work with all

a complete and comprehensive

acteriscs or personalies and

techniques.

markets and me frames, whether

analycal tool, I believe studying

rules. Besides wave counts and the

it is stocks, ETFs, futures, or Forex.

and using Ellio wave will improve

interacon with Fibonacci exten-

It is a valuable technical tool

your chances for success.

sion and correcon relaonships, relaonships,

ute me period.

because it is comprised of wave

change, requiring an assortment

there is a me element and what

paern. In order to help determine the top or peak of a ve

Using soware that includes a Fibonacci correcon and expansion tool, we can easily determine a price objecve with fairly good

Tren Tra ng In c ator s

accuracy. If your charng soware

higher frequency of the 2.618 per-

The one drawback in using this

included examples of integrang

program does not have this fea-

cent rao work as well. See Figure

method is the consideraon of 

longer-term pivot point analysis

ture, my website, NaonalFutures.

10.2 for illustraon.

how much me it takes for a swing

such as weekly and monthly me

measurement measurement to reach its objec-

periods. These seem to be more

ve. Using Fibonacci extensions

eecve in predicng both me

 just gives us an idea of a poten-

and price turning points.

com,, provides a free pivot point com and Fibonacci calculator.

Another method to predict the peak for wave ve is to take the

Once we determine the overall

measurement measurement from the boom of 

measurement or amplitude of 

wave one to the top of wave three

wave one, extend that amount by

and mulply out by 1.618 percent.

3.236 and add that sum to the bot-

See Figure 10.3.

tom of wave one. I have seen a

al move; it does not give us a me frame in which the move

Wae Two

will occur. The move could take

As you can see in Figure 10.4, the

days, weeks, or months to meet

second wave usually retraces .618

the objecve. That is why I have

percent of the sum of wave one.

Tren Tra ng In c ator s Wae Tee

needs to be followed is to make

The third wave is one of the most

sure the third wave is a true wave;

important because this is where

it cannot be the shortest of the

you will see your trend conrma-

ve waves.

on occur. This wave is the largest

Wave two can at mes retrace

in the chapter on Dow Theory.

100 percent of the enre previous

These are commonly referred to

trend or wave one, but not beyond

as 1-2-3 paerns and resemble a

the beginning of that wave. This

head and shoulder chart paern.

means that if it is a bullish cycle,

Traders have also been able to use

wave two will not make a lower

the number two point to predict

low, and if it is a bearish cycle, it

the top of wave ve by taking the

will not make a higher high. This is

sum of the price move in wave

what technicians generally consid-

one, mulply that amount out by

er the makings of “W” paerns or

1.618 percent and then add that

double booms or “M” paerns

gure to the price point of the bot-

or double tops. This was discussed

tom of wave two.

of the three impulse waves. It is

Wae Fou

accustomed with heavy volume.

The fourth wave is the correcve

From a fundamental aspect, this is

wave. It usually gives back some of 

where you will start to hear more

the advancement from the third

and more bullish news, which will

wave. One may see measuring

in turn support the move upward.

chart paerns like triangles, pen-

Generally speaking, the top of 

nants, or ags during the fourth

wave three equals a measurement

wave. Triangles, pennants, and

of the length of wave one mul-

ags are connuaon paerns and

plied out by a factor of 1.618 per-

generally break out in the same

cent. Another way to determine

direcon as the overall trend. The

or predict the top of wave three

most important rule to remember

is to take the overall length of 

about the fourth wave is that the

wave one, mulply that amount by

low of the fourth wave can never

2.168, and then take that sum and

overlap the top of the rst wave.

add it to the price point of the low

Here is where we will nd tremen-

of wave two. Technicians jump on

dous trading opportunies once

the trend and place market orders

you can idenfy the fourth wave.

to enter a posion from the break-

As the principle applies, applies, old highs

out above the number one wave.

(resistance) once broken will later

You usually see a large increase

turn into a new low (support) on a

in volume and open interest at

re-test as we covered in our chap-

that point. This is where break-

ter on trend line analysis.

away gaps will occur. One rule that

Tren Tra ng In c ator s Wae Fie

the Extraordinary Value of the

beyond Wave A, then another

nal rather than chase the market

The h wave is usually the stron-

Ellio Wave Model  , both of which

cycle begins in the opposite

as it declines and sell short right as

gest for some commodies, such

can be found at www.tradersli-

direcon.

it starts building an upside reversal

as coon, soybeans, gold, and cur-

brary.com.. brary.com

rencies. This is where the longest

To summarize what we’ve learned

“leg” of the waves will be formed.

in this chapter, here are the main

It is also during this nal phase that the price advance begins to slow. From the rule of “mulple

that forms forms into wave wave ve. Beer

SUBJECTIvITy IN ELLIOTT WAvE

yet, with the knowledge of what

principles that you should focus

There are more observaons to

might look like you can:

on when working with Ellio Wave

understand which are quite sub-

•

project a prot objecve

Theory:

 jecve rather than absolute rules •

lter a trading system to look

regarding Ellio wave theory.

techniques,” other indicators and Wave A is usually mistaken

Having the ability to look at a

for beer triggers to sell short

cs begin to show signs of being

as a regular pullback in the

chart and being capable of seeing

as the maturity of a long-term

overbought in a bullish trend, or

trend, but this is where you

the corresponding trends or waves

trend starts to dissipate. dissipate.

oversold in a bearish trend. We

could possibly start seeing the

in the market will help you deter-

This will also help you not to sck

noce during this period that

makings of “W” or “M” pat-

mine which side of the market to

terns(1-2-3 paerns), double

around in a trade too long.

the market is beginning to lose

trade on.

momentum and that the trend

tops or booms, or a head and

may be exhausng itself.

shoulders chart paern.

oscillators oscillators like MACD and stochas-

•

the characteriscs of a h wave

One such setup is idenfying a higher right side double bot-

•

Wave B is a small retrace-

CONCLUSION

tom form as wave two forms.

ment back towards the high of 

Remember, it will look like a dou-

Robert Prechter of Ellio of Ellio Wave

wave ve, but it does not quite

ble boom or correct near the

Internaonal is one of the world’s

reach that point. This is where

.618 percent retracement level.

foremost leading experts on Ellio

traders will exit their posion

Wave two can also retrace 100

wave. If you see yourself wanng

or begin seng up their posi-

percent of wave one, so armed

to learn more into this subject, he

on for a move in the opposite

with this informaon, you will

has wrien several books on this

direcon.

have a beer idea of how much

Wave C conrms the end of 

to risk on a trade. For example, as

subject, and I would would recommend that you explore them, along with and his video courses Trading the Ellio Waves and Understanding

•

the uptrend and when conrmaon is made by going

you see a fourth wave develop, it will be beer to wait for a buy sig-

QUICk QUIz 1. Ellio wae analsis can wo in all maets an all me fames. a. True b. False 2. A complete Ellio wae ccle consists of ow man waes? a. b. c. .

5 3 8 13

Tren Tra ng In c ator s 3. Wat in of waes ae sai to moe wit te main ten? a. b. c. .

Correcve Fractal Dow Impulse

4. In wic wae will a tae see a ten conmaon occu? a. b. c. .

Wave one Wave two Wave three Wave four

Fo te answes to tis qui, o to TaesLiba.com/TLEcone.. TaesLiba.com/TLEcone

C

In Closing

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