How Elliott wave analysis helps you as a forex trader with built-in, risk-defining safeguards
November 29, 2012
By Elliott Wave International
Elliott wave analysis is not a crystal ball. (No market-forecasting method is.)
But here’s what is remarkable: Even when your Elliott wave forecast doesn’t pan out, you have built-in safeguards to alert you — and help you manage risk. Here’s a real-life example.
Going into the November 14 low, USD/JPY charts had been showing an impulsive downward Elliott wave pattern. Impulses are 5-wave moves, but on November 13-14, the pattern looked incomplete: the fifth wave down seemed to be missing.
Here’s a chart our Currency Specialty Service subscribers saw early on November 13:
So, our analysis on November 13 suggested that USD/JPY would fall further. But USD/JPY just would not fall; instead, it went sideways.
That suggested to our Currency Specialty Service team that the wave (4) you see in the chart above was extending. Perhaps it was developing as another Elliott wave pattern — maybe a contracting triangle? This chart and analysis described to subscribers that scenario:
“A bearish fourth-wave triangle is another idea that’s in a position to yield new lows in wave (5). Resistance rests at 79.655/765.”
Note that line: “Resistance rests at 79.655/765” — it represents the very risk-defining safeguards I mentioned earlier.
How? Well, there are things that Elliott wave patterns just are not allowed to do. In a contracting triangle (an A-B-C-D-E formation), prices must stay within converging trendlines — and they cannot overlap the start of wave A, the origin of the pattern. Resistance at 79.655/765 was exactly that: the price point where the contracting triangle interpretation would be invalidated.
Practical application: If you were bearish on USD/JPY on November 14, you could have used the price area of 79.655/765 to manage your position risk.
As you probably know, USD/JPY did not go sideways for long. Nor did it go down. Soon after, it went higher and breached that key resistance level:
When one Elliott wave pattern ends, another one begins. As soon as that key resistance in USD/JPY was breached, a new road map for the Japanese yen became clear.
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This article was syndicated by Elliott Wave International and was originally published under the headline USD/JPY: Lemons into Lemonade. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.