September Commentary

Have you ever been caught in a situation where the trade you entered has turned to the worst very rapidly; you know the fundamentals have not changed that much so you expect the stock to pull through this new trend. The questions you must concentrate on is how long and how bad is it going to get. I hear most of you saying if you had put a stop loss you would not have to ponder these questions. Fair enough for the short term but the long term might view it differently; some might say, if the fundamentals are still good, this may be an opportunity to get some more while averaging the cost down. Actually both views make sense depending on the assumptions used and trade horizon. Yet both must ask themselves: is this the best time to sell (or buy)? If Elliott waves are used to trade impulses, the corrections also have their use. The most important is obviously that their end precedes an impulse, beyond that we rarely consider using the top/bottom of a correction to exit/buy.Once the reverse trend is established, there is no point for the short term trader to wait for it's reversal; he must exit at the top of the correction and may be enter in an opposite trade to take advantage of the coming impulse. For the long term, the view is the reverse where one waits for the impulse to be near an end, to add to a position. In both cases the timing is critical and the assessment of the type of wave is even more critical. Only with Elliott methodology enables to discriminate triangles and corrections from impulses. Granted it is not always accurate but the average is well over 50%. Let's use an example like Sirius (SIRI) and assume one took a position at the bar shown by the thick arrow (August 4th).

 

 

Click on the image to enlarge.

The next day, the stock opens and closes above our entry. The day after comes the disaster. By the next day, to get out is a costly affair hence the need for a well thought out plan. Let's assess the situation on day 3; the price closed above the low and that is an encouraging sign, the next good thing is the Elliott oscillator that is just a touch in bearish territory and finally the price is holding above the 155 days moving average. On the bad side, we know this is now a bearish trend impulse and we need to evaluate how far down it may take us. If we decide to stay in and exit when wave iv will end, we must have clues that the impulse will not carry us too far from where we are and of same importance, what can we expect from wave iv in terms of price retracement? Before anything else, we put a stop loss at the trough of wave iii so if the price heads south, we opt out. The next day, the price is on the rise again and we have time to make all the projections. The rule of alternance although not always true, says that since wave ii had a small retracement, we can expect wave iv to retrace further into wave iii; we also know that the gray label for wave iii is a very bad omen, usually when wave iii is shorter than wave i, you can expect the dominant trend to resume. If we don't gauge the top of wave iv, we will ride down to the stop loss very quickly. Therefore our strategy is to use an ATR to raise the stop loss as we go along, this way we lock in some of the retracement before we exit.

To conclude, once we have a strategy in place, we have a certain control over the damage. Of course all this will take time and if we had exited on the second or third day, we could have entered another trade with better conditions. The issue is really to preserve as much capital as you can and what you already have is worth many times what you can expect from a trade.