Trading with Wolfe Waves

[RichardCox 10]

Wolfe Waves are used in technical analysis to represent trading patterns that occur naturally in all markets, according to the rhythms of supply and demand. In these Waves, supply and demand unfolds in 5-wave structures as opposing forces in the market struggle (but never actually reach) an equilibrium in prices. Wolfe Wave patterns can unfold over both long and short term time frames and these patterns can be used as a basis for forecasting where (and when) prices are likely to travel in the future.

 

When used to their potential, Wolfe Waves can help traders make accurate predictions with respect to equilibrium areas for prices associated with a specific asset. When conducting this analysis, certain elements must be in place when looking at the Wolfe Wave structure:

 

• Waves 1 and 2 must show symmetry (equality) with Waves 3 and 4
  
• Waves 3 and 4 will remain contained in the channel formed by Waves 1 and 2
  
• Wave 4 will fall inside the channel that is formed by Waves 1 and 2
  
• Time intervals separating all Waves show periodic regularity
  
• The third and fifth waves are often equal Fibonacci extensions (i.e. 127%, 162%) of the prior channel price points
  
• Wave 5 surpasses the trend line generated by the first and third Wave (this action is used as the trigger for trades)
  
• Price targets will be generated (and altered) by the trendline that comes from the first and fourth Waves
  

 

Understanding Advanced Channels Analysis

 

Price channels tend to be one of the aspects of technical analysis that traders use early on in their trading careers. This is largely because of their simplicity and reliability in determining likely price direction, trade entries and exit levels. But while basic channels can provide a good (and quickly visible) indication of where prices will travel within that channel, there is not much information within these patterns to indicate when channel breaks are likely to be seen.

 

Here, the strength of identification patterns (like the Wolfe Waves) become most useful, as they can help traders to forecast channel breaks - not just in terms of price distance but in terms of time as well. The extension of the breakout can be viewed in relation to the size of the original channel, and this information becomes useful when looking at potential profit targets for successful trades. Here, we will look at the main factors to consider when using Wolfe Waves as an advanced channel analysis technique and the ways these price patterns are typically used when generating profits.

 

Wave Elements

 

Practitioners of Wolfe Wave analysis will argue that these patterns were discovered (rather than invented), as they seek only to represent the natural equilibrium exchange that is constantly fought between buyers and sellers. Traders use this information primarily to find balances between market time and changes in price. These elements taken in combination help to improve on the accuracy of the analysis.

 

But, in all cases, the most critical factor when looking at these structures is symmetrical behavior, as wave cycles that are marked by equal intervals in time tend to produce the patterns with the highest accuracy. To understand this, we will first look at the bullish and bearish structures when dealing with Wolfe Wave patterns. These can be seen in the first attached graphic.

 

When looking for these formations, traders often watch for the following situations:

 

• Rising price channels that are found in uptrends
  
• Declining price channels that are found in downtrends
  
• Sideways price channels that are found in periods of market consolidation
  

When looking at the basic wave structures, it is important to note that the fifth waves (in both the bullish and bearish formations) breaks through the channel containing Waves 1/2 and 3/4. These breaking moves tend to be viewed as a false breakout or an invalidation of the previous channel formation, and trade entries will usually be placed in these areas.

 

This fifth wave “fakeout” is a common feature of the formation but is not a requirement for the validity of the formation. The extension move at point 6 is viewed as the take profit region, as this larger move is the most profitable price distance that is forecast by the Wolfe Wave structure. To determine the sixth price point, we connect Wolfe points 1 and 4 in the structure (using trendline EPA as shown in the following chart examples). Fibonacci extension levels are also helpful in determining these profit target areas.

 

Trading Examples

 

To see how trades play out using the Wolfe Wave structure, we will look at two chart examples. The key aspect to remember is that trade entries are taken at Wave point 5. Drawing a trendline through points 1 and 4 give us a potential exit point for the position. The following examples will both show bearish trading possibilities, with the next graphic showing how the entry levels and profit targets are constructed. As you can see, the move that follows point 5 gives us the largest price distance, which essentially means that this zone gives us the best chance for achieving a large gain in the trade.

 

Now that we understand the basic trading structure, we can look at a live candlestick chart to get a sense of how a trade might play out in the active markets. In the third attached graphic, prices in the CAD/JPY rise to the fifth Wolfe point at 77.20. This channel pattern gives our entry signal. Note the Fibonacci relationships between all legs of the formation.

Prices then see substantial follow-through and fall to the sixth point of the wave structure (the trend line drawn through points 1 and 4) below 74.20. The massive extension to the downside gives the signal that a corrective period might be seen next, which means that profits should be taken and the trade should be closed.

 

Conclusion

 

Proponents of the Wolfe Waves pattern analysis will argue that these formations workin price forecasting because of the ways they represent the natural equilibrium that is sought in the markets. These constant battles between buyers and sellers create the environment for what could be massive moves as these patterns reach completion. Of course, these structures involved some degree of subjectivity, perhaps even to a larger extent than what is normally seen in chart analysis.

 

For these reasons, some traders are skeptical of the validity that can be attributed to these formations when forecasting future price moves. Proponents of these techniques will argue that profitability can be achieved as long as these formations are properly identified in real time. This is easier said than done, and it is clear that trading with Wolfe Waves does take a higher degree of practice (relative to many other techniques) in order to master and replicate on a consistent basis.

[BlueHorseshoe 10]

The only other explanation of Wolve Waves I have read is in Raschke and Connor's 'Street Smarts'. Your explanation is a hundred times clearer - nice work!

 

It would be interesting to hear here from anyone who trades regularly with these patterns.

 

Attached below is a text file containing easylanguage for a 'Wolfe Wave Indicator' cribbed from an old thread on Trader's Lab.

 

BlueHorseshoe

wolfe wave easylanguage.txtFetching info...

[nelsonhimes 10]

What to say about trading because every day we have to learn something new and face many things in the market. Thanks for the good article to read.

[sidra 10]

Being a woman, I am interested in forex trading. but i heard people saying women cant do this job :crap: weird :haha: any one has the right reason? does trading is specific for gender???