May Commentary

Trading Elliott waves is far from a routine where one would look at a chart or an exploration, make a trade decision and wait until the price is ripe. It is more like being in a bump car and although you are in command you may still get driven away from your course. The good side is that you can always reassess the situation and act accordingly because each pattern gives you some predictability and milestones to gauge the progress. This month example is Digital Think (DTHK) at 10 minute bars and its erratic behaviour from an Elliott standpoint. From a short term perspective it is going through a correction and at first sight the wave three should resume its bearish path. Yet the demand index is very strong and the wave issued from the May trough could be of an impulsive nature. To be certain, one could wait until the price breaks above the April 29 peak at 2.54. In addition to the demand index, Elliott provides us with another clue, the retracement level; the price has retraced a touch more than 75% of the previous peak. The odds are that it will exceed the peak unless some bad results are published. A final clue is provided by the fact that the trough of wave one at 2.30 has been penetrated, an event that rarely takes place in Elliott methodology (wave four should not retrace into wave one territory).

 

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On the other hand, if it does not exceed the peak, the price must then fall below the 2.18 trough. This gives you two opposing strategies as is often the case in real life. You can trade both (not at the same time) by using proper trading rules. For example, I would have taken a long position at 2.30 when the price retraced above the trigger level of the wave I am watching. The light gray circled 3 shows the end of a wave three that does not meet all Elliott's criteria. The wave is shorter than the wave one and wave three may never be the shortest of the impulse waves, then wave five will have to be shorter than three; unfortunately we don't know at this point and for that reason the label is grayed warning us of the pending status. Nevertheless the next wave is either a wave four or a correction (if wave three was to resume its course), or a bullish wave one. By taking position early, I can still exit with a good profit if the price goes to 61.8% retracement (expected since wave two did not retrace much, rule of alternance) and starts falling again. The price could also break the peak which would increase the return.

Obviously taking a position at 2.30 means there was an exposure when the price fell to 2.20 before resuming its bullish path. This exposure can be limited by putting a stop loss which would exit you from the position until you can clearly see the direction. The level of drawback one can tolerate is personal but it should be a level where you will feel comfortable even if you are taken out. Elliott enables greater confidence in analysing the market and taking position, whipsaws are less frequent and the feeling of control given by the milestones (price objectives, retracement or exttension) is a bonus.