AtoZ Markets - The Elliott Wave theory is getting an increasing attention more than ever. This trend is only bound to increase. The Elliott theory identifies patterns on the historical charts of a financial instrument which is well defined and can be measured. Elliott wave is not just a theory. It is a methodology. How do we use Elliott wave as a methodology especially in the area of trade management? Can you cut losses using Elliott wave theory?
You will agree with me that a good trading system/methodology should give an entry price, exit price and prospective targets. More than all these, a good methodology/system must give clues on how to manage an opened trade. How to cut losses, extend profits and even add to a winning position. A trader that understands all these is only bound to be successful in the short and long term. There are technical and methodical ways of cutting losses (i.e adjusting stop loss). No technical methods makes it as easy and well-defined as the Elliott wave theory. The following gives a practical example on EURJPY setup we shared on 17th May. We have used the following chart in our setup.
EURJPY Elliott wave analysis, H2 (click to zoom)
We identified the chart above as a clear impulse wave. Impulse wave patterns are often followed by at least a 3-wave correction. There was a breakout at 124 thereby giving a selling opportunity with stop loss at 125.9. There are other methods of entry like selling the pullback or use price action on a higher time frame etc. Let's assume a trader sold at breakout -124. He is risking 190 pips and probably committed 3% of his fund targeting 6% and above. What happened next? Can he cut losses using Elliott wave theory or extend his profit?
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How to cut losses using Elliott wave theory: EURJPY study
EURJPY Elliott wave analysis, H2 (click to zoom)
Price made more dips away from the entry price giving initial small profit which is far from the targets set. From this point, we start managing our trade. We aim to cut losses using Elliott wave theory or of course maximize our profitability. Remember? Cut losses short, and the winning positions run.
Next step: Go to the lower time frame to study the sub-waves of the dip.
EURJPY Elliott wave analysis, 15 min
The chart above shows the sub-wave of the dip as an impulse wave. If there won't be any extension, we can expect a 3-wave correction soon, to 50-61.8% Fib retracement of the dip. The whole setup will be invalid at 125.9 where the stop loss is set.
Next step: wait for price reaction
EURJPY Elliott wave analysis,15 min
Price made a 3-wave rally slightly above the 61.8% Fibonacci retracement to 124.95. After which, price made an effort to push below with a double top. We can can tag this as the end of a-b-c to adjust stop loss to. We therefor, reduce our stop loss to this level. 190 pips has been cut to 95 pips or 3% cut to 1.5% or $100 loss cut to $50. After this we wait for price to continue downside by breaking the wave b of the correction. What happened next?
Wait for price to prove you wrong or right; don't panic!
We were stopped down at an adjusted stop loss. This is how professional traders cut losses using Elliott wave theory. The pullback does not mean that the setup is invalid. Trading is different from analysis. The objectives of a trader should be to extend profits and cut losses. We have achieved our objective. We have cut losses using Elliott wave theory.
What if price continues downside, can we enter again?
EURJPY Elliott wave analysis, 15 min
Though the present rally looks like a 5-wave move that will break above 125.9. A 3-wave correction still goes until price breaks above. If price breaks below, it is good to have a re-entry. Our initial setup is not invalid yet. The stop loss can be at the same initial level and target at the same level. What will be difference now is the risk allotted for the re-entry. In order to continue the 'cut losses' process, a trader can invest the fund he was able to cut successfully from the first entry i.e 1.5% or $50 in this example. You can apply the same 'cut-losses' process. Professional traders don't compound on losses, they rather cut. They only compound on profits. We will see that in another example of how Elliott wave theory can help us manage our trades. Stay tuned.
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