March Commentary

This month I will address the question of profitability with the use of Elliott waves. Many believe that buy and hold is as good if not better than any system. The test I ran using MetaStock? Enhanced System Tester and data from Nasdaq-100 Index. The system is AO Elliott Waves normal and the parameters are the following: equity is raised to $1,000,000 so we can actually trade the indice, the time period from today to 1405 bars ago, trading the 21% amplitude, using no optimization, interest on unused equity of 3% annually and commissions at 1% in and out. This system will issue a buy/sell short signal when an impulse wave 1, 3, 5 or C is detected and confirmed. The confirmation is the price move necessary to firm the last leg of the zigzag move. In the same manner, it will issue a sell/cover short signal when the wave ends and the end is confirmed. This simplistic approach takes us to the foundation of Elliott filtered waves. While you can improve on the entry and exit signals by using Fibonacci golden ratio and appropriate stops, the use of raw signals gives a true picture of the mechanic and the risk of trading waves. If a wave does not have enough momentum, the time needed for the confirmations, will consume all the profit potential and leave you with a loss or breakeven. This is the reason for trading first an impulse rather than a correction. Even then, the risk is quite substantial thus the need to use adequate stops. The premices thus established, the system reports four trades of which three are profitable.

 

It also tells us that if we had used the buy and hold strategy during the same period, we would have lost .36% of the equity. In other words, AO Elliott Waves normal outperformed the buy and hold strategy by 80 times or 7,953.46%. It would be unfair to conclude our comparison at this point; we need to know what makes up this profit. A look at the composition reveals that the average trade profit is $41,878 or a total of $125,635 for all profitable trades. The total reported profit is $285,700 made of the trade net profit and the interest paid on the equity while out of the market. The interest amounted to $188,113 and consequently the trade net profit is $97,587 or one third of the equity appreciation. To check on the number, add the lines Trade Profit and Trade Loss and you will get the same number. If you wonder where the commissions are accounted for, they are netted in the trade profit or loss reported.

Getting back to our comparison with buy and hold strategy, if you had left your equity in an interest bearing account (3%), you would have beaten the strategy by $179,579. This is less than the $285,700 with trades keeping in mind that the interest is applied to the net equity (initial plus profit and loss from trades). In conclusion, Elliott waves generated a higher return than buy and hold or simple interest. The system was used in its most passive way, using only wave confirmation signals and none of the Fibonacci or Gann tools. While there is a risk associated with forecasting swing points, the use of stops will protect capital and some of the accumulated profit. Elliott waves methodology is not as a profit machine but it is a good disciplined approach to investing.