Question of the Week: 4/28/2010

In your Trading updates you use more than just wave theory to do market analysis and trading. How do you decide what type of analysis to use and when?


This is one of the most important questions I've ever been asked in this forum and is a concept every professional trader should understand. The value and attention I place on various forms of market analysis changes with time and is directly tied to which phase of price development a market is in.

In a recent interview I discussed the 3 stages of clarity all wave patterns experience. The early and late phases of a pattern's development I categorize as "specifically predictable." That is when wave theory is most useful for prediction and trading. As a market moves into wave-B or wave-2 of a pattern, the "general" phase of predictability begins. At that time, one must simply be satisfied with the ability to predict general market direction. Near the center of a large, complex formation (especially during corrections), one may not be able to predict any market action no matter what form of analysis is employed.

As a result, from nearly 30 years of watching markets, I have developed a method of dealing with each phase of a pattern's development. Below is my checklist depending on whether a market is in its specific, general or unpredictable phase of development.

(during wave-1 or wave-5 of an impulsion OR the first and last leg of a correction)

This is the best time to put your full faith and trust in wave structure, ignore the news, ignore your friends, the papers, and do what wave theory suggests. At the very beginning of a new trend, or the very end of an old trend, there is virtually no need for anything other than wave theory to predict and trade a market and place stops and project targets.

(during wave-2 or 4 of an impulsion OR the second and second-to-last leg of a correction)

This is when other forms of trend analysis become useful (I use my proprietary MOAT index, but any "trend following" analysis could work or at least help). Once a trade is taken, an approach to stop placement and movement becomes necessary since wave theory is not always clear enough to place appropriate stops. Neely River technology plays an important part in my updates during this phase of a market's development. When wave structure is not clear enough to provide useful levels, it is the best approach I know for placing stops, moving stops and exiting positions

(during wave-3 of an impulsion OR the middle portion of all corrections)

Virtually no form of analysis helps or works during this phase of a pattern's development. For that reason, I try to resist forecasting during this phase and try to keep trading to a minimum. But, realize, during this period, a market will "tease" you with possible market termination points that turn out to be wrong, sometimes over and over. The larger the pattern, the more times you may be "tricked" into thinking a top or bottom is forming (my forecasts and trades in the S&P 500 from June 2009 until March 2010 are a testament to the problems and difficulties created during the unpredictable phase of a market's development). The most important thing you can do during the unpredictable phase, if you are going to trade, is keep risk very low (1% of capital or less, which is what I've been doing in my NEoWave Trading service for the last year or more).

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