tactical trader

Over many years, I have come to realise that the simple approach to analysis is often all that is needed to uncover excellent trade opportunities. As analysis techniques inevitably become increasingly complex (satisfying the human ego?), it is clear to me that one of the simplest yet most powerful trade set-ups in a trader’s daily routine should be the simple ABC correction.

Although not a new pattern (R. N. Elliott covered it in detail in the 1930s as part of what came to be known as Elliott Wave theory), its profit potential has been largely overlooked. Its usefulness in generating low risk/high return trade set-ups may have suffered because of its very simplicity. However, this pattern, when properly identified, enables the trader to start the trading process by uncovering potentially ideal opportunities both quickly and decisively.

First, though, what is meant by a simple ABC correction? In the MTPredictor™ software, it is defined as a 3 swing correction against the main trend, in which the third swing exceeds the price extreme of the first swing. If the third swing falls short of the end of the first swing, it is not a simple correction. See the chart below:

The chart above shows an example on US S&P 500 stock Calpine (CPN) on 16 September 2005. A strong, impulsive downtrend was followed by a simple 3-swing upward correction, in which the third swing exceeded the high (in this case) of the first corrective swing up. This is a typical, simple ABC correction against the main trend.

The key question is: Why is the identification of this type of correction so important? The answer is that, once the simple ABC correction is complete, the main trend normally resumes. Looking at the current example a few months later, it is clear that once the correction (as identified on the chart above) was complete, Calpine lurched downwards again, to new lows, as below:

As such, the end of this simple ABC correction represented an ideal place to short the market to take advantage of the drop…