My reliable Dow setup led to a perfect trade

Last Monday, I covered a very interesting set-up in the Dow. In fact, the hourly chart displayed one of my all-time favourite patterns – the ‘five/three’.

I mentioned in my coverage of GBP/USD on Friday that the chart there also was displaying a five/three, and that there were several more current examples in different markets. So today, I want to show that the Dow set-up last week was a highly reliable trading opportunity.

Below is the Dow chart I posted last Monday:

Dow Jones spread betting chart

The in-progress five down pattern off the mid-July high was a very clear impulsive move – and by that, I mean the third wave was long and strong, producing very low momentum readings along its length. That is the signature of a third wave – and allows you to conclude the main trend is now down and in alignment with the third wave.

Incidentally, another feature of most third waves is that counter-trend moves are usually very small and brief – and this one certainly fits the bill.

According to Elliott wave theory, any rally following a third wave is very likely to be counter-trend and will usually be in a three-wave form of some description. And that is indeed what the market produced last week. The counter-trend rally had managed a Fibonacci 50% retrace of the move down – a typical turning point. That was my wave 4 high – and an ideal place to enter a short trade.

In addition, this rally was contained within the trading channel of my tramline pair, and when the rally had completed, there was a clear momentum divergence going into this high – a vital clue that the rally was likely over. The main downtrend could then resume.

I forecast the Dow low two weeks ago

Last Monday, I left the market testing the lower tramline and if my scenario was to play out, I needed to see a rapid descent to at least the third tramline drawn parallel and equidistant, which was my first target.

Soon after I posted last Monday’s chart, the market did indeed begin its descent and rapidly made it to T3 in a scalded-cat bounce. But it didn’t stop there – just admire all of the hits and kisses on the tramlines I have drawn parallel and equidistant from the first pair. In fact on Friday, the market made an accurate hit and bounce on T6 which was in new low ground – and did enough to say that wave 5 could be in.

Dow Jones spread betting chart

So now I have a likely complete five down, as I had forecast at least two weeks ago. That is the power of using simple Elliott wave concepts, combined with my tramline and Fibonacci principles. In fact, this is a textbook example of how to use my methods in real time.

With the Dow having made this new low on Friday, can we really say that wave 5 has actually ended? If we can, then the next move will likely be a counter-trend rally.

This is the time to step back and look at the daily chart to see how all this fits into the bigger picture. I have drawn in my green tramlines that I have been working on for some time. Currently, the market has declined to test the lower tramline support, which is also the Fibonacci 38% support level. That implies there is a great deal of support near current levels and adds weight to the conclusion that wave 5 has indeed very likely terminated.

Dow Jones spread betting chart

That implies the counter-trend rally should be starting from around current levels. In any case, at least a profit of around 400 pips on the shorts taken at the wave 4 high could be banked – a very satisfactory trade.