April Commentary

We will continue the discussion on profitability of Elliott waves. Last month, we saw the performance of Nasdaq 100 Index. The result may biased because we used only one security. An exploration was run on NYSE, ASE, NASDAQ, TSE and CNDX universe of 14,000 securities. The exploration is not optimized, it uses the same rules as last month. The rules are: an entry when the impulse wave has been confirmed by price retracement and an exit when the corrective wave has been confirmed through the same method. In real life, you could use faster signal or projections; this setup is used because it requires no intervention extraneous to Elliott's theory. It is the most conservative. The results are displayed in the six columns MetaStock provides. The exploration scanned three different magnitudes (Cycles) to give an overview of what is available. The headings are for each magnitude: the percentage of profitable trades over total trades (%), the number of good trades as the integer and the number of trades as the fractional (Trade).

 

Note that the profit may be very small and that the commissions are not included in the calculation. The purpose is to find the number of waves that can be traded with success even in adverse conditions. The first observation is about the percentage of success. While most of the number are relatively high, some are as low as 16% for a specific magnitude. If you look at the other cycles for the same security, you will see that the results are superior. It brings our attention to two important realities in Elliott's applied theory. First, even an impulse wave is not a guarantee of trading success, timing and protective stops are crucial for that reason. Second, you must select the proper magnitude or cycle to maximize your trading success, trading only the large waves when the security moves in smaller waves is contrary to common sense. The second observation is about the number of trades. Obviously, the smaller the cycle, the larger the number of waves thus of trades; the point is that these trades are spread over 3 to 5 years of history. There are not that many trades and it is easier to monitor and avoid whipsaws. You will not completely eliminate whipsaws for the market will always reflect investors sentiment as it takes place.

Most of you must be wondering why I put such a report on display. Because there is a need to say that Elliott waves are not a free lunch. Used without knowledge or appropriate tools, it can lead to disastrous results while with discriminate use, it will improve your trading success. Many will make predictions about the market or argue about the wave number or a specific pattern; while they may be right, your interest is not in this area but in how you can use personally Elliott's knowledge to trade. The interest in the wave count lies in the predictability of the next few moves. The value of the predictions is akin to probabilities with a similar margin of error. Your skills must be in exerting control as much as in interpretation. An analogy is that of a sailboat, you need wind and you also need to steer in the right direction, otherwise you will end where you don't want to be. The waves are the wind while entry, exit and stops allow you to steer (or trim the sail).