Macro Elliott Wave Trading: Two Losses Scenarios
Combination and Extensions
Common Introduction
I am an Elliott Waver. I was also a professional trader in a proprietary trading firm and a Macro hedge fund. Elliott Waves is the primary tool I use together with Fibonacci levels to trade. From there, other technical analysis indicators like oscillators (i.e. RSI), and moving averages became the secondary tools that I used to confirm my wave counts, and to manage risk.
The “macro” part of trading is really a thought process of how I weave a story to piece together what Elliott Wave is telling me, and it forms the fundamental belief on how events in the world will play out and how the financial markets will react (or sometimes, the financial markets is the cause of how world events plays out). However, there is one core belief that is the foundation of my trading:
I could be wrong.
From this core belief, I would say:
Strong Opinion, Weakly Held.
Two Main Loss Scenarios
Even with a mastery in Elliott Waves, there are 2 scenarios that will cause me to make losses when applying Elliott Waves to actual trading, and until today, I have not found a solution.
Before I go into the details of this, note that losses are considered as “operational costs” to a trader and thus it is “normal” to have them as when you are in trading as a business.
Combinations
One of the two scenarios is what we call a “combination”. This is the corrective form of “extensions”. Meaning a corrective wave structure did not lead to an “impulse” wave going back to the main direction of the wave of a higher degree.
I know that the previous sentence is a mouthful and will only make sense to another Elliott Waver. So below is a picture to depict this.
From the above, an Elliott Wave trader may held on a long or scale in after breakout (from top of sub-wave 1) expecting a strong move up. But then, price turns down. And sometimes, strongly. For a trader trading in stocks, this may be a problem if the last point in the blue arrow was a close and the stock opens the next session gapped down instead of up.
Extensions
An extension is a another scenario where an Elliott Waver may make a loss. But honestly, extensions are really an easier to handle scenario than combinations.
Elliott Wavers know that stops are placed above peaks or troughs because a new high or low immediately invalidates an existing wave count.
The reason why extensions are easier to handle lies not only in the risk management part, but also in the recovery part. Most extensions belongs in wave 3 (and wave 5), and thus a break of the high (or low), means that we can immediately flip our position from short (or long) to long (or short). The PNL recovery is also usually quick because “extensions usually mean strength”.
For example, we might think that a wave 5 has ended, but in reality it is wave 1 of 5 has ended and we are going into wave 3 of 5.
Managing the risk of being wrong
Stop loss.
A seasoned Elliott Waver has a certain advantage when it comes to technical trading because he/she can flip sides. While most traders are broadly classified as either a reversal trader (e.g. swing trader) or a breakout trader, an Elliott Waver is both. It’s kind of like “Are you a Cleric or a Sorcerer?” (referring to my favorite “Might and Magic” series RPG).
The answer, actually is, “I am a Druid.” For those uninitiated, Druid is a hybrid class of Cleric and Sorcerer in the game although they can’t use Light and Dark Magic (yes, I digressed. What can you do?)
