How to Apply EWA Forecasts

Introduction

From time to time, especially when new visitors come to the web-site of Alpari Ltd., I receive letters concerning forecasts on the basis of the wave analysis (EWA — Elliott Wave Analysis). Some beginners try to understand the situation on the market and the main principles of the wave theory and apply it. Others begin with critics, claims and advice. After a brief correspondence misunderstanding or superficial knowledge of the principles of the wave analysis becomes apparent, as well as desire to get a real profit from someone else’s forecasts, even without reading the materials on the topic.

I will try to answer some of the frequently asked questions here in order to save your and my time in the future. Where necessary, I will reference to the more complete information.

So,

What is Wave Analysis?

From my point of view this is one of the most powerful and flexible instruments of the graphical analysis and financial markets projection. Wave Principle, originated from Charles Dow’s theory, was developed by Ralf Nelson Elliott. Moreover, some elements of wave patterns structure are given in book «Profits in the Stock Market», by Harold M. Gartley, 1935, published three years before the first book on the Wave Principle of Ralf Elliott. Fibo coefficients were not mentioned in that book, they have appeared later, when those materials were retold by our contemporaries (e.g., Fibonacci Ratios with Pattern Recognition by Larry Pesavento, 1997).

In the context of modern wave theory any financial chart is a reflection of sentiments of the market participants. Indeed, looking at the formed chart it is not difficult to specify when bulls or bears won in the market and when they were almost equal in strength. But Elliott was the only one who managed to specify separate patterns of price movement in each phase of the market, then he compiled the list of wave patterns, which described any possible market movement, and specified their mutual influence and the main regularities of their recurrence. On the back of this information further market movement can be forecast in the shape of this or that wave pattern projection, supposing, what the chart will look like in the future.

I think I should not retell the basis of the Wave Principle here, as it is given in Wave analysisand my book Elliott’s Code: Wave Analysis of the FOREX Market. Note that this information should be studied carefully rather than just looked through.

At the same time, I would like to draw your attention to the fact that the Wave Principle is not a finished trading system, which yields profit, but a complicated prognostic instrument, with the help of which such a system can be created.

What Information EWA Forecast Provides

Any EWA forecast is based on the survey wave counting, that is on the supposed set of interrelated wave patterns, which in the author’s opinion has been formed by the market. With the help of it we can understand what phase of the market it is now, whether we should open a position immediately or it’s better to wait till the current wave pattern completes.

The type and peculiarities of the forming pattern are assumed on survey wave picture analysis. If its forming is confirmed and it is doubtless, on this time-frame it gives us in addition supposed direction and the shape of further price movement as well as possible projection of the point of this pattern completion, that is projection of supposed point of the trend reverse.

It should be noted that EWA is not formalized enough, that is why any wave scenario is quite subjective. Unfortunately, «the true» counting is impossible because of such nonmathimatic nature of this forecast instrument, and disputes over the correct view on this or that wave construction become useless, any waver just has his own perception of waves. Moreover, one and the same part of the chart can be marked differently with the set of different wave pictures because of the lack of unique methods of wave patterns specification and presentation of the general wave picture, that is why a variety of alternate variants of wave counting arises. In this case, as a rule, most probable scenario from the point of view of an analyst (P >> 50%) is taken as the main scenario, other variants are considered to be alternate ones.

For each scenario clear-cut boundary conditions of its existence are specified. As a rule, these are critical and confirmatory levels, which breakout finally confirms or annuls the chosen variant. It is quite usual when a critical level of the main variant is a confirmatory level for the alternate scenario and vice versa. Sometimes price can be fluctuating between such levels, giving rise to a variety of new intermediate variants of wave counting and turning the scale in favor of one variant and then in favor of another one. At such moments the main and alternate scenarios may be almost equally probable (P = ~ 50%) before the price breaks the boundary levels, specified before, or before the wave picture changes principally.

As a rule, the state of dynamic equilibrium is observed when a corrective phase of the market is forming or when a trend breaks out. From the practical point of view there are several ways to avoid such a situation. The easiest one is to be out of the market, waiting for the wave picture to clear up. The most aggressive way is to go to a smaller time-frame and make short-term trading plans there. The most conservative way is to go to a larger time-frame without closing positions and wait until the correction ends or the accepted scenario is annulled or confirmed (for the H4 time-frame and larger ones it is reasonable when swaps are positive, leverage is small and positions are long-term).

The Choice of the Optimal Time-frame

From my point of view, an optimal time-frame is a time-frame, which allows to see the full current picture on the chosen wave degree, as well as every necessary detail and further perspective (projection) of the price movement according to the accepted scenario. Though a time-frame is not enough to have an idea about the full wave picture, wave specification is better to be considered successively from the Grand Supercycle to the Micro-6.

As there is no unique link between wave degrees and time-frames and no more than 3-4 wave degrees can be clearly seen in a chart of a usual size, it has been found out in practice that shift from a larger degree to the smaller one can be done discretely, when time-frames of the charts are approximately 3..6 times different. In this case succession of the general wave picture is preserved between the charts.

That is why in my EWA forecasts, as a rule, monthly, weekly, daily, 480-min and 120-min charts are used. In case it is necessary, I can use 720-min and 360-min charts, in some cases any appropriate chart from 90-min to 1-min can be used to specify waves (e.g. refer to Basement-0604).

In annual forecasts monthly and weekly charts are mainly used, in monthly forecasts — weekly, daily and 480-min charts whereas in daily forecasts 480-min, 120-min and other charts are used (if necessary). In this case succession of the wave picture is preserved from the larger degree to the smallest one.

Why are 120-min charts a usual minimum specification of the current market? The reason is quite simple, the smaller the time-frame, the more possible scenarios of the current wave counting arise thus losing the general wave picture and the trend of the market. That is why it was specified in practice that price noise of the Forex market giving rise to a variety of «false» scenarios is not as obvious on 120..60 min charts as on the smaller charts. At the same time on the 120-min chart general wave picture can be more clearly seen than on the 60-min chart and succession with 480-min chart is preserved.

At the same time taking a detailed wave counting on the 120-min chart as a basis, any waver can mark all necessary areas with required precision if necessary. Though such additional specification of the earlier marked chart is not so necessary for real trade. It is required only as an «intellectual exercise» or checking of some separate nodal constructions. That is why 120-min chart has been chosen as a usual minimum time-frame.

Conventional Signs, Used in EWA

I am not going to describe Wave Counting Marking in details, its detailed description is given in my book. If you want to understand it you should know it. With the course of time any beginner realizes that understanding of «letters and numbers» combination can help to dip into the future.

I will briefly explain some subjective labeling in EWA forecasts charts (e.g. see Daily-150207).

Figure1. Legend for EWA forecasts.

How to Apply EWA Forecasts

Knowing the basis of the wave analysis, a trader can use EWA forecasts as basic data to make his trading plan, as EWA forecasts have:

general concept (reason to open a position),
supposed direction of the price movement (direction of a position),
the main critical level (original stop-loss) and
rough target projection (possible take-profit).

More detailed information to make your own trading plan you can find here(in Russian). When the situation in the market clears up, I give graphical recommendations on orientation points of entry and possible targets (e.g. see Daily-150207).

Well, that is not all. That is why beginners who do not know the wave analysis well enough and those who do not know anything about the technique of positions opening and management should not use such EWA forecasts to enter the market as any forecast is just a supposition, which reveals its author’s opinion at the moment of its release. In any case any figure of the trading plan should be understood before a position is opened.

The traders who place orders proactively to catch a new trend at the very beginning, must remember that such strategy is agressive, with high risks. In such a case it is simply necessary to place protective stop orders behind that ending of the wave that you supposedly consider to be the turning point of the local or global trend.

If necessary, this article may be complemented.

Reference