Last Friday, I said “January is shaping up to be a most lively trading month”.
That turned out to be an understatement. Last week, the Dow Jones index had one of its most volatile weeks in years. A trader’s dream!
Trading in this scenario is certainly heart-stopping, but potentially very profitable for the nimble trader. Get it right, and you can rack up gains of 200 to 400 pips or more in a few hours.
Today, I want to talk you through how I did just that during Wednesday’s incredible roller-coaster action.
How to bet against the crowd
Very simply, my strategy was to bet against the rallies and buy the dips. But that’s more easily said than done. It takes a lot of nerve to go against the crowd.
There was a lively start to the week. On Monday, the Dow had a 100-pip rally and then a swift 200-pip decline. And on Tuesday the market rallied as a result of some strong earnings reports from the companies which comprise the Dow index.
This was the picture on Tuesday afternoon:
The massive rally to above 17,900 – point Y on my graph – knocked out thousands of automatic buy-stops (buy stops protect short sellers by limiting their losses as the markets rise). This ‘running of the stops’ is a common feature of markets.
But the important point from my perspective is that the rally fell ten pips short of last Friday’s high. The high at point Y was ten pips under the high at X.
Why did that matter to me? It meant my original Elliott wave labels from my analysis earlier in January were still intact. You see, if the rally had carried beyond Friday’s high, my Elliott wave labels would need to be amended.
This told me what I needed to know – the market was heading down.
Elliott wave theory told me my target
And sure enough, late on Tuesday the market broke hard below an important chart support level at the 17,600 level.
On Wednesday, the market rallied and then fell to a new low, which set up a lovely five-wave Elliott wave pattern. It’s shown below in the ten-minute chart:
I took that screenshot early on Wednesday, just as the fifth Elliott wave was about to make its turn.
At that point we were at the fifth wave – which is the end of a complete Elliott wave pattern. Elliott wave theory says that when the fifth wave ends, the next move is likely to be a relief rally. But where exactly would the fifth wave end? That was the burning question.
How I called the bottom
I found an answer – and it was derived from a knowledge of one of Elliott’s guidelines.
You see, relief rallies often end at or near the previous wave 4 high (which, in this case, was at the 17,640 level). And what’s more, theory says that relief rally would likely be an A-B-C form (ie, showing three changes of direction within the overall trend).
So I had everything I needed to place a low-risk trade: short at the 17,640 area and place a close stop just above.
Let’s see how this forecast worked out:
The rally hit my target of 17,640 right on the nose, before the market fell hard. What a fantastic demonstration of the power of Elliott wave theory!
How much should I cash out?
As it happened, I used my split-bet strategy (in which I bank some of my gains on a winning trade, while letting a portion of the trade run) and took 300 pips out within hours. That was a gift too good to ignore.
How much should you hedge your bets by locking in profits, in this situation?
This is where your own time horizon comes in. If you are a longer-term trader looking for a very large move, you will not be so concerned with the rallies, provided your original stop loss is not hit.
If you are more of a day trader, you will be looking to exit on the first sign of strength and will not sit through a large adverse move. Such moves often turn out to be far larger than you expect – or hope.
So although I write here about trade entries and the methods I use to give me low-risk trades, entering the trade is relatively the easy part. It is the trade management – deciding how much to cash out, and when – that gives you the headaches.
A note on the Swiss central bank action
Many traders were caught out by the action to remove the CHF/EUR peg at 1.20. Sadly, most traders were on the wrong side of that trade, believing the ‘promises’ given by the bank to defend the peg and drive the CHF lower.
So much for bankers’ promises – and I hope you were not among the victims.
Because this currency is always highly manipulated, I never advise trading it and rarely bring up the chart to illustrate a point. Recent action has confirmed the wisdom of avoiding it.