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How to use Trend Following and the Elliott Wave Theory to own the stock market
– by Ryan Henry of TrendLizard.com
At face value, it seems as if a trend following trading strategy and an Elliott Wave trading strategy would be very similar. At their core, they’re both trying to identify the dominant trend and trade it. But boy does it play out differently in the real world.
A trend following system is based on using some measure of trendiness to determine the direction of a trend and then participating in that trend. Some folks, like the infamous Turtle Traders, used a new 20-day or 55-day high (aka a breakout) to buy into a trend. Others use a sudden increase in the speed of price movement, or maybe a sign from some indicator such as two moving averages crossing one another. In any of these cases, the only way a new trade is taken is if some technical event indicates that a trend is already underway.
The average Elliottician (i.e. a follower of the Elliott Wave Theory) tends to take a different approach by anticipating changes before they actually show up on a chart. I have met a ton of Elliotticians over the 15-plus years that I’ve provided market analysis. I’d say 90% of them have been significantly more excited about the prospects of a change in trend then they are about the current trend. It’s understandable; no other theory even attempts to quantify a trend to the extent that Elliott Wave does, and with that comes a sense of control. Instead of trading what is at hand, the trade becomes anticipatory about what could be.
I have issues with both methods in their purest forms. As far as trend following goes, I never thought it was a good idea to buy every time some technical event happened, like every time a new 20-day high was set or every time an optimized moving average crosses over another moving average. In my mind it’s not that black and white, and trend followers will readily agree that you need to rack up a lot of losses in search of the big gainer. As far as Elliott goes (or at least the way it is used by most), it almost becomes a contrarian or countertrend strategy since it’s used more to anticipate changes rather than follow the current trend. I have found that its very difficult for the Elliottician to take a trade in the middle of a trendy pattern – it’s much better to get in right at the start of a new one. That’s why I am a fan of using the best parts of both methods while removing their shortcomings.
The beauty of trend following is that it focuses its efforts on exactly the one thing we know makes money in the market – following a trend, and sticking with it until something happens to indicate it is over. Too many trading methods put you in a position to take profits way too early, and that can crush your long-term earning potential. On the other hand, Elliott Wave is masterful at identifying the difference between trendy and non-trendy movement. I know of no other method that comes close. So we can use Elliott’s ability to identify if a market is in trendy or non-trendy mode at any point in time, without getting jumpy every time a wave pattern might have completed. We can use that information to follow the trend like a dog – sticking with the move not until we’re satisfied with our return, but until a price event happens that insists the trend has changed. How else are you going to find the type of trades that are going to change your life?