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38% of the Wave 3 Oscillator
5
3
4
Elliott Oscillator
(not shown to any scale)
Divergence
0
Minimum
90% Pullback
Required
Maximum Pull Back = 38%
of Wave 3 peak in the
Opposite Direction
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Applying Technical Analysis
Using The Elliott Oscillator in Wave Three
¤ When a market rallies with a strong Elliott Oscillator as in Chart A, the rally is classified as a Wave Three.
Chart A
Chart B
Wave 3 ö
Once Wave 3 is over,
profit taking sets in.
Strong Oscillator ö
Oscillator
Pullback to
ï Zero
¤ Once Wave Three is over, the market will pull back on a profit taking decline.
During the profit taking decline, the Elliott Oscillator should pull back to zero (as shown in Chart B).
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Applying Technical Analysis
Using The Elliott Oscillator in Wave Four
¤ Once the Elliott Oscillator pulls back to zero, it signals the end of a potential Wave Four profit taking decline as shown in Chart A.
Chart A
Chart B
New Highs ð
ñ
New
Buying
ö
Profit Taking
ö
Decline Over
Profit Taking
Ended
Oscillator
Pullback to
Zero
ò
¤ New buying comes in and the market makes new highs (as shown in Chart B).
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Applying Technical Analysis
Using The Elliott Oscillator in Wave Five
¤ The market is making a new high with less strength in the Elliott Oscillator as shown in Chart A.
Chart A
Chart B
New High ð
When 5 Waves are com-
plete, the market changes ð
direction
With Good Oscillator
Divergence
ñ
Previous
Wave 4
Oscillator
Low
Divergence
¤ This indicates that the current rally is a Wave Five and once the Fifth Wave is over, the market should change direction.
¤ When the market changes direction after completing a Five Wave sequence, the previous Wave Four will become the first target. In Chart B, the market changed direction and is trying to test the previous Wave Four low near 3630.
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Applying Technical Analysis
OSCILLATOR BREAKOUT BANDS
A major task in using Elliott Wave Analysis is to identify Wave Three’s accompanied with a strong Oscillator. In the past we have done this by
visually comparing the size of the cur-
rent Oscillator with that of the past.
The Oscillator Break Out Bands pro-
vide an UP Band and a LOW Band.
Anytime the software labels a Wave
Three, the Oscillator needs to be
comfortably above the Break Out
Band. We recommend a setting of
80% for these bands.
The chart on the left is the Daily Swiss
Franc Dec 94 contract. Here the soft-
ware labels a Wave Three Rally and
this rally is accompanied by a strong
Oscillator that is breaking above the
Breakout Bands.
Therefore, this Wave Count can be
Oscillator above
used for this market at this time. An-
Breakout Band.
other example is shown below where
the Oscillator is above the Breakout
Band and confirms with the Elliott
Wave analysis.
Confirmed Wave Three in progress.
Oscillator above Breakout Band. î
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Applying Technical Analysis
Adding PTI (Profit Taking Index) – Theory
Using Elliott Wave analysis, any major rally or decline can be classified as a Wave Three.
Once a Wave Three is in place, Elliott Wave theory continues to look for a Wave Four Retracement followed by second attempt in the same direction. This last phase is called Wave Five.
WAVE FIVE – 2nd
5
attempt in the same
direction.
3
WAVE FOUR
Retracement
WAVE THREE
4
WAVE THREE
Initial Strong
Initial Strong
Rally
4
Decline
WAVE FOUR
Retracement
3
WAVE FIVE – 2nd
5
attempt in the same
direction.
RALLY PHASE
DECLINE PHASE
The above patterns are completed Five Wave sequences and are great after the fact.
However, while the pattern is in progress, the Trader is left with a major dilemma at the end of the WAVE FOUR Retracement. This dilemma is because many times the 2nd attempt fails to materialize.
WAVE FIVE – 2nd
5
Anticipated
5
attempt in the same
WAVE FIVE
direction.
3
3
WAVE FOUR
WAVE THREE
WAVE THREE
4
Retracement
Initial Strong
Initial Strong
Rally
4
Rally
WAVE FOUR
Retracement
Market continues to
drop without reversing.
Normal Five Wave Pattern
False Five Wave Pattern
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Applying Technical Analysis
From our years of research and development, we designed the Profit Taking Index (PTI).
The Profit Taking Index compares the Buying/Selling momentum in Wave Three with the Buying/Selling momentum in Wave Four. This comparison is then passed to an algorithm that calculates the PROFIT TAKING INDEX VALUE.
CASE 1 – Normal Five Wave Pattern
WAVE FIVE – 2nd
5
attempt in the same
direction.
Statistically, if the Profit Tak-
3
ing Index is Greater than 35,
the market exhibits a greater
WAVE THREE
Initial Strong
tendency to initiate a Fifth
59
Rally
Wave or a 2nd Attempt
4
PTI
Phase.
WAVE FOUR
Retracement
CASE 2- False Five Wave Pattern
3
Statistically, if the Profit Tak-
ing Index is LESS than 35,
29
WAVE THREE
4
Initial Strong
the market generally FAILS
Rally
PTI
to initiate a Fifth Wave or 2nd
Attempt Phase.
Market continues to
drop without reversing.
CASE 3 -Failed Five Wave Pattern – Double Top
3
DOUBLE TOP
5
If the Profit Taking Index is
LESS than 35, and the market
WAVE THREE
Initial Strong
still initiates a Fifth Wave Phase,
Rally
29
the potential for a DOUBLE
4
WAVE FOUR
TOP becomes very high.
Retracement
PTI
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Applying Technical Analysis
Adding Wave Four Channels
Wave Four Channels are another proprietary study developed along with the Profit Taking Index. The Profit Taking Index mainly deals with Buying/Selling momentum at different stages. The Wave Four Channels deal with time. After a strong rally, the retracement phase is allowed a certain amount of time prior to initiating the 2nd attempt (Wave Five) Phase.
Statistical studies show that if the retracement phase consumes too much time, the 2nd attempt phase diminishes its full effect. The Wave Four Channels are three time/price lines.
If the Wave Four Retracement holds above the Wave Four channels, the odds for a strong 2nd attempt are greater.
If the Wave Four Retracement breaks below the Wave Four channels, the odds for a strong 2nd attempt is very low.
WAVE FIVE – 2nd
5
attempt in the same
direction.
3
PTI Greater
WAVE THREE
59
than 35
Initial Strong
4
Rally
ch 1
PTI
ch 2
ch 3
WAVE FOUR
Channels
WAVE FOUR
Retracement holding above
Wave Four Channels
The Significance of Wave Four Channels
1) If the wave four retracement holds above the first channel (displayed in BLUE), the statistical odds are better than 80% for a strong wave five rally.
2) If the wave four retracement holds above the second channel (displayed in GREEN), the statistical odds for a strong wave five rally is only 60%.
3) The third channel (displayed in RED) is a final stop, because once this channel is broken the odds for a new high in wave five is very low. The very few times a fifth wave is generated after breaking the RED channel, the rally becomes a tedious, slow and drawn out process which literally eats out your patience and option premiums.
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Applying Technical Analysis
Profit Taking Index & Wave 4 Channels
¤ In Chart A, when the Elliott Oscillator pulls back to zero, the Profit Taking Index (PTI) should be greater than 35. In this case the PTI is at 47 which indicates normal profit taking in the Wave Four Decline.
Chart A
PTI > 35
Chart B
ñ
ñ
Buy For New
Highs
Prices Holding Above
the 2nd Wave 4 Channel
¤ In addition, the prices should hold above the Wave Four Channels which indicate the ideal length of time for normal profit taking. In Chart A, the prices are holding above the Wave Four Channels.
¤ Everything here looks good for a buy.
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Applying Technical Analysis
Adding Displaced Moving Average (DMA)
¤ We introduced the DMA concept in 1988. The DMA is a normal moving average shifted to the right. The purpose behind the DMA is to allow the market to continue its momentum.
¤ When the market finally completes a Five Wave sequence, prices will cross the DMA.
DMA
Sell on cross
Fifth Wave Highð
of DMA
÷
õ7 Period MA
displaced 5
periods
ñ
DMA stays out of the way and lets the
market continue its momentum
¤ At the end of Wave Five, use the DMA to enter the trade. We suggest a 7 period moving average shifted (displaced) to the right by five periods.
¤ WARNING: The DMA is designed to enter positions at the end of a Fifth Wave and on certain patterns at the end of Wave Four. DO NOT USE the DMA as a tool to buy or sell at other places. The accuracy for the DMA as a tool by itself is less than 21%.
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Applying Technical Analysis
Elliott Wave Rules & Guidelines —