How to Follow Trends and Catch Reversals

09/27/2010 2:15 pm EST

Focus: STRATEGIES

One common error many traders make is to fight the trend, thinking that by doing so they are being clever contrarians. This tendency is even more pronounced among those who are learning—but have not yet mastered—the Elliott Wave methodology. A little knowledge can indeed be a dangerous thing for those misapplying it.

At TradingdaNumbas.com, we follow a rigorous Elliott Wave approach, but we don't fight the trend. As they rightly say, "the trend is your friend." This does not mean that we get 'married' to a position, but we respect the trend until it weakens. It also doesn't mean we are not contrarians—far from it. We look for and find exhaustion signs in the market, coupled with sentiment extremes that show us when the market is vulnerable to a turn. Meanwhile, the crowd who fought the prior trend until that point finally capitulates and embraces the now tiring move, all at the worst possible time.

In this article, we will show our approach to the market reversals of the past four months in what has been an exciting summer for unbiased traders looking to profit both from the upside and downside market swings. To be on the right side of the market consistently, without erroneous bullish or bearish bias, has to be the closest thing to the 'holy grail' of trading. We hope these examples will further solidify the idea that it is really an achievable goal.

In mid-June, as the market kept rallying from our 1040 support area, we began to key in on a major resistance/target area above, as the first chart below indicates. The second chart displays how we further refined the *exact* target area ahead of time; the next chart then shows how the market turned practically on a dime from our target area. All charts shown in this article were submitted to our members in advance, as part of our TdN daily market updates.

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It is important to note that the market again reversed off the same area later in August. Such levels may seem 'obvious' by now, but as you can see, TdN offered them to members before the market even recognized them, back in June! This is the true power of objective, unbiased Elliott Wave analysis.

After the decline began, and initial support was breached, we identified the Elliott Wave count as bearish, as shown on the next charts below. After further loss of support, a sideways range formed from June 24 through June 28. However, we were still prepared for more downside, to be confirmed by a breakdown from the range. The anticipated breakdown yielded a move of nearly 60 points on the S&P.

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Once the breakdown came, the market accelerated past lower support, which became resistance; at this point, in late June, we had already zeroed in on the eventual target area below, around 1010 on the SPX.

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The last two charts show the remarkable precision that is possible with proper analysis of the Elliott Wave structure and key levels, as practiced at TdN. The market made a major turn off our exact support level and rallied for more than 100 ES points for the next six weeks. This was not a straight line, of course, but we again anticipated the twists and turns until the market was ready for another major reversal.

The whole rally from the July lows was punctuated with “perma-bears” calling for a crash, while we at TdN not only anticipated the low, but respected the rally as it progressed, pointing out key support and resistance areas along the way. We will save this is as the topic of our next market review installment.

Hopefully everyone can appreciate the true value of being able to precisely pick tops or bottoms. This is not an easy endeavor; most fail while trying. The proper approach to the market does not come naturally; however, the market itself is always right. If you have struggled with deciphering the market's moves, we encourage you to come to the right place at TradingdaNumbas.com, and unlearn the old bad habits.

By the staff at TradingdaNumbas.com

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