How To Approach A Trade With Trend Direction Unknown

Everyone is an expert with the benefit of hindsight. It is easy to give a successful trade as an example of how things should be done. In reality, however, trading is messy and uncertain. Even the clearest pattern or setup is not 100% guaranteed to provide the expected results. There is no such thing as a worry-free trade as the market can always change its mind mid-way.

Instead, more often than not, there is more than one possible scenario to keep in mind. Most traders feel obligated to pick their favorite, which makes their approach very subjective and therefore often inaccurate. Elliott Wave analysis, on the other hand, allows us to wait for the market to tell us which way to go by providing the so-called invalidation and confirmation levels.

A recent example in USD/JPY can help illustrate how to approach a trade when the short-term direction of the trend is unknown. Let’s start with a chart we published as an Elliott Wave PRO update on August 17.

The possibility that wave 4 was still in progress as a w)-x)-y) double zigzag couldn’t be ruled out. In that case, the recovery from 130.40 to 135.59 would be limited to a simple a-b-c zigzag in wave x). This would mean we should prepare for more weakness in wave y) to drag USD/JPY below 130.00 before the uptrend could resume in wave 5.

Both counts were equally probable. Under these circumstances, inexperienced traders would simple pick one of them and see what happens. Our approach is different. We don’t like gambling, so when the odds are close to 50-50, we simply stay aside and wait for the market to give us a hint. In this case, we only had to identify the two key levels to pay attention to. A breach of either of them would confirm one of the counts and invalidate the other.

Wave ‘a’ of y) was a clear five-wave impulse, followed by a three-wave recovery in wave ‘b’. In order for the bearish outlook to survive, wave ‘b’ was not supposed to exceed the starting point of wave ‘a’. This meant 135.59 was going to be our invalidation level for the bearish count and confirmation level for the bullish one. As long as USD/JPY traded below it, the bears still stood a 50% chance. A surge above it would put the bulls firmly in the driving seat. In contrast, a drop below 132.55 was going to tilt the scales immensely in bearish favor. Less than a month later now, most of you already know how things went.

USD/JPY rose past 135.59 the very next day, August 18. This confirmed the positive outlook and invalidated the negative one. Targets above the top of wave 3 made sense, so we initially thought the 140.00-142.00 area is likely to be reached. It turned out we weren’t bullish enough as wave (iii) has already taken the pair to the 145.00 mark. 132.55 was never threatened.

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This is the kind of if-then situations Elliott Wave analysts deal with on a daily basis. Having an opinion about different topics is an important part of everyone’s personality. In the uncertain environment of financial markets, however, personal opinions are no better than a coin flip. Patience often makes all the difference. So why not leave them at the door and let Mr. Market decide which way the trade is going?

Original Post

Written By: EWM Interactive