How do you use the Wave Principle to set up trades?
Simply using the rules and guidelines of the Wave Principle can give us some great trading set-ups. Let’s begin with rule No. 1.
Wave two can never retrace more than 100% of wave one. It’s not that the market can’t go there, it’s just that if it does, you know one thing for certain – that wasn’t wave one and wave two!
Look at the figure below. We have a five-wave advance followed by a three-wave decline, labeled waves (1) and (2). Second waves typically retrace more than half of wave one, with a .618 Fibonacci retracement of wave one a common target. So in anticipation of a third-wave rally – a traders’ bread and butter – one could look to buy at or near the .618 retracement of wave one. OK, then what?
Well, your position is based on the idea that what you’re seeing is waves (1) and (2), and that’s valid unless that wave (1) origin is broken. If that’s the basis for your trade, then a breach of that point means your basis is gone, so at one tick below the origin of wave (1), you should probably be gone too! Time to reassess and look for the next opportunity!
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