I had initially considered using the title "Combining Theories" for today's article but I had to rethink that after talking with a friend who is quite knowledgeable with Elliott Wave Theory. I was explaining to him how a fellow trader had turned me onto the tactic of waiting for a 3 wave push - technically 3 intra-session waves in the same direction - which culminate in our buy or sell zones as a filter for our existing method. (Our buy and sell zones are based on a retracement zone starting at 50% and ending just beyond .618) The actual RTT level which determines whether a pattern is bullish or bearish is represented by an orange line when resistance and a green line when support - see Figure 1. We only trade in the direction of the majority of patterns for our given horizon, i.e. day trader, swing trader etc. - see Figure 2.

Because this counter-trend cycle is most often a total of 5 waves - 3 up and 2 down today -- I was referring to it as an Elliott Wave cycle. That is an incorrect reference. In the Elliott Wave lexicon there is no phrase for a counter-trend 5 wave pattern - technically such a cycle or pattern does not exist to EW purists as far as I know. So I will call this excellent filter of a formation a Generic EW pattern. The Generic or Bizarro EW has been quite prevalent over the last couple of months since I have been tracking it and helped us avoid a loser today.

(click to enlarge)
Figure 1. Generic 5 wave pattern ending at overlapping RTT levels in USDJPY today

Figure 2. RTT Ratio for USDJPY, a.k.a. the brains behind the operation

In Figure 1 we see the 3rd leg up of the generic EW formation stopping right at an intra-session RTT level, in orange. Previously a turn lower from there would be a sell signal. Yet by waiting for the 5th leg, or 3rd push higher we avoid the loser and put ourselves into a position to take the next sell signal. In live class today while highlighting the trade I actually voiced that the sell signal following the 5th push might not work out given the powerful reversal in stocks yesterday and in Euro overnight, yet the signal did work and proves the point that when in doubt we must follow the method not our opinion.

The key to trade selection for us is still the RTT Ratio, a.k.a. the "brains behind the operation" - see Figure 2. We use the ratio to determine which market to focus on and which direction to trade it in. Better said we use it to determine which uptrend we are looking to buy dips in, or which down-trend we are looking to sell rallies in. I certainly will continue to track the Generic EW formation as a filter for our method. As a rule of thumb any new tactic should be tried out in a demo account first, where we can wait for the first drawdown before deciding to going live.

Jay Norris is the author of "The Secret to Trading: Risk Tolerance Threshold Theory". To see Jay highlight trade set-ups and signals in live markets for free go to: Live Market Analysis

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