Reprinted from of St o c k s & Co m m o d i t i e s magazine. © 2012 Technical Analysis Inc., (800) 832-4642, http://www.traders.com INTERVIEW Trading With The Elliott Wave Doing The Wave With Jeffrey Kennedy

Jeffrey Kennedy is chief commodity analyst at Elliott Wave International (EWI). With more than 20 years of experience as an analyst and trader, he writes and edits Futures Junctures, a premier forecasting package that focuses on Elliott wave analysis of the commodity markets. Kennedy also leads Elliott Wave Junctures, EWI’s newest educational service, and provides daily video lessons on the Elliott wave, technical analysis and trading. In addition to being published in Stocks, Futures and Options magazine, Traders’ World magazine, and The Technical Analyst, he has appeared on Yahoo Finance’s “Breakout” and Business News Network’s “Berman’s Call.” He is also an adjunct instructor in the quantitative and computational finance program at the Georgia Institute of Technology, where he teaches technical analysis. St o c k s & Co m m o d i t i e s Editor Jayanthi Gopalakrishnan and Staff Writer Bruce Faber spoke with Kennedy on October 10, 2012.

eff, can you tell us about what back this year, it will be my fourth year you do? teaching there for their graduate-level When I look for a potential I am the chief commodity class in trading and technical trade, I always begin with J analyst at Elliott Wave Inter- analysis. I teach a portion of that. I national (EWI). I’m pushing love technical analysis. the wave principle. That is 20 years at EWI, actually. I have been my canvas. counting waves for 20 years. I consider How did you get started in this busi- myself an Elliottician, but even though ness? I use the wave principle as my primary I got into it because I thought this the summer of 1993 and have been here technical tool, I am passionate about was the place to be. I was fascinated ever since, and have enjoyed every mo- technical analysis as a whole. I love Steve with Wall Street, and stockbrokers and ment of it. Nison’s work with candlesticks. I love currency traders, the final years I was ’s work with Bollinger in college. I wanted to be the guy who Can you tell us about the Elliott wave? Bands. I love J. Welles Wilder’s work really knew what was going on. At the The was de- with index (RSI) and time I didn’t want to be a broker because veloped by in the even Andrew Cardwell’s influence on they basically have marching orders mid-1930s. What he observed was that the RSI as well as Gerald Appel’s mov- that their brokerage house gives them the moves in these recogniz- ing average convergence/divergence to follow. able patterns that are essentially fractal. (MACD). I am familiar with all the great The analyst, on the other hand, seems Basically, the wave principle is a form of names in the industry, and I have been to know what’s going on. It is the stock technical analysis based on pattern recog- fortunate enough to actually meet some market analyst who understands what nition and crowd psychology. Within the of these people over the years. is going to go up and what is going to actual discipline of the wave principle are So even though I am a trained El- go down. That is why I zeroed in on the two types of waves. The wave principle liottician and the wave principle is my analysis side of the business versus sales primarily gives the analyst and trader a primary technical tool, I still find great or being a broker. tool to view price action. That context is value in a lot of the other disciplines that I live near Atlanta and became famil- provided by one of two waves: motive technical analysis has to offer. In fact, I iar with the wave principle and Robert waves and/or corrective waves. teach technical analysis at one of the local Prechter’s organization, Elliott Wave There are five basic or five core wave universities, Georgia Tech. If I can make it International (EWI). I joined them in patterns that I work with as an Elliotti- Reprinted from Technical Analysis of St o c k s & Co m m o d i t i e s magazine. © 2012 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

cian. Within the motive wave family, a context for price action. As such, it is there are two waves: an impulse wave not a trading methodology. Analysis is the mastery and an ending diagonal. Within the cor- I go all over the world teaching people of observation. If you rective wave modality or the corrective about the wave principle. I’ve been to are an analyst or an wave family, you have three. You have a India, South Africa, Australia, Singa- zigzag, what we call a flat, and then we pore, Hong Kong. I encounter people Elliottician, you are have a . Those are the five core who, when I ask, “Do you find value in looking at the markets wave patterns that Ralph Elliott identi- the wave principle?” they answer with and theorizing what fied. These patterns again are fractal in “Yes, I love it.” But when I ask, “Do could happen. nature. You can pull up a one-minute you have difficulty trading it?” they also price chart of the S&P and you can see say they do. The reason why is simple. these fives and threes. The wave principle, as it stands, is not a disciplines, they are not going to come Impulse waves, which are motive trading methodology. You are utilizing up with the same results. That is why it waves, develop in five wave structures the wrong tool for the wrong job. takes time, practice, realistic expecta- or five wave forms. Corrective wave tions, and talking to other people who patterns, like zigzag and flats, unfold Then what is it? are experienced. in three waves, which are identified as The primary value of the wave prin- I’ve made a lot of expensive mistakes waves A, B, and C. It is not uncommon ciple, and it says this in the A.J. Frost as an analyst and as a trader, but I have for Elliotticians to hold conversations and book Elliott Wave also learned some very valuable lessons. using phrases like, “We have a nice Principle, is that it provides a context It is just part of the learning curve with five up here” or “We have a nice five to view price action. Now the wave what we do as traders and analysts. down here.” What we mean is that with principle can be adapted, which is what Again, my heart is in the wave principle. five waves up we know the trend is up. I have focused on as an Elliottician. I I value it greatly, but it takes some under- If we have five waves down, we know think about what Ralph Elliott would standing what it can and cannot do. the trend is down. As a trader, because have done if he had lived another 10 or My primary focus at EWI is not to just I do both, I look for those three wave 20 years. I think he would have been very teach people about the wave principle, countertrend moves, or those corrective aggressive at actually applying what he but how to apply it in a real-world trad- wave patterns. uncovered about the market, more from ing environment. In other words, I look for the zigzags, a trading perspective. That is what I fo- the flats, and the triangles, because what cus on here at EWI. I look at things like You said you liked other technical indi- I like to do, both as an analyst and as a where do you get in, where do you get cators. Do you use them in combination trader, is identify a trending market, and out, and where do you pull the trigger with the wave principle to help you make if it is an uptrending market, I like to on a trade. The wave principle answers entry and exit decisions? focus on buying the pullbacks and wait these questions, but again, it takes time Absolutely! Analysis is the mastery for those corrective waves to unfold. and practice to understand the tool. of observation. If you are an analyst Conversely, in a downtrending market, Now trading, that’s a different conver- or an Elliottician, you are looking at if I see three wave rallies, those are my sation because I am as passionate about the markets and theorizing what could opportunities to sell the market. If the trading as I am about technical analysis. happen. Trading, on the other hand, is reader is simply familiar with those five What I have learned about trading is that more immediate. It is more of a mastery patterns, it will serve them well. [Editor’s it is all about psychology. Some of the of your self, your emotions, your mind, note: Information on those five patterns people I admire the most with regard to and your money. can be found at www.elliottwave.com/ the importance of trading psychology The primary focus of a trader is not club/educational-resources.aspx.] would be Mark Douglas in his book The what could happen, but what is happen- Disciplined Trader, and Van K. Tharp in ing. There is the distinction between a Doesn’t that require a lot of patience? some of his books. I admire both men good analyst and a good trader. A good The primary value of the wave principle greatly because they have hit the nail on analyst has to evaluate probabilities of is that it provides a context for the analyst the head with respect to what it takes to what could happen. A good trader has or trader to view price action. It lets you be a consistently successful trader — to focus on what is happening, and take know, for example, within an impulse psychology. advantage of that. wave you have five waves labeled 1, 2, That is one thing I say quite often when When I look for a potential trade, I 3, 4, and 5. That fifth wave move is the I teach: it is the man, not the tool. Say always begin with the wave principle. final move within the sequence. There are I give two people a pencil and paper; it That is my canvas. I am looking for very few tools that allow you to identify doesn’t mean they can write like Shake- patterns that I recognize. In fact, I’ll go that this move up, a final push up, is a speare. Granted, they both have the same through, say, 100 stock charts and ask terminating wave. The wave principle tools, but not the same skill. Similarly, if myself, “Do I see a pattern I recognize?” allows you to do that. Again, it provides I give two people two technical tools or If I go through a few dozen, I will find Reprinted from Technical Analysis of St o c k s & Co m m o d i t i e s magazine. © 2012 Technical Analysis Inc., (800) 832-4642, http://www.traders.com INTERVIEW

one or two with very clear Elliott wave nation point of wave C has come into technician can look at several markets patterns. At that point I begin to apply play, I should see further confirming and give you an opinion about those my other tools. Say we have a five-wave price action of my assessment by seeing markets in a matter of minutes. advance that is followed by a three-wave the proper reversal candlestick patterns. decline. That three-wave decline is what Better yet, if I see them on multiple time Let’s talk about money management. an Elliottician would refer to as a zigzag frames. As Steve Nison teaches, it is What kind of money management or a five-three-five pattern. great when you have a bullish engulfing strategies do you apply? Once I see my three-wave decline, pattern on the weekly chart level, and The term money management is very what I do next is to go to the intraday within those five trading days you might much like the term technical analysis. price charts and make sure that each experience a morning star reversal pat- It is a catchall phrase that includes a wave of that structure has the appropriate tern on the daily chart level. That is how number of different ideas. My style subdivisions. It is a five-three-five pattern, I like to combine the multiple disciplines of trading is very conservative from a so in wave A, I want to see five waves that technical analysis offers. money management point of view. I fol- that don’t overlap. In wave B, I want to Technical analysis is a rich field of low what most professionals do, which is see a three-wave price move, and then in study. A lot of the work that Robert never risk more than 1% to 3% of your wave C, I want to see another five-wave Edwards and John Magee did with flags portfolio on any given position. I am a move. Ideally, I would like to see, because and pennants, and head and shoulders, is big fan of not trying to take a trade that we are dealing with a zigzag, the slope just as applicable today as it was then. I does not offer a better than one-to-three of wave C actually be more shallow than talk about head and shoulders in much risk/reward ratio. If I am going to risk a what is experienced in wave A. Now I of my own writing. dollar, I want to make three. I don’t want pull in my indicators. There was an excellent example of a to risk a dollar to make a dollar. very nice head and shoulders in soybean Then again I very much like the idea Which ones? meal from a few weeks ago. It is one of the of waiting for confirming price action. I I will usually look at RSI, MACD, or markets I follow. I follow about 20 com- am a trend trader. I like to find trending MACD histogram. I do that because I modity markets, the primary markets, and markets, and if it is going up, I like to want to see divergence in price and di- about 150 stocks fairly regularly. buy pullbacks. If it is going down, I like vergence in momentum. Say I am using to sell bounces. I am not a fan of picking the RSI. Where wave C should terminate That’s a lot of markets. tops and bottoms. I am more than happy beyond the extreme of wave A, I want to When I teach at Georgia Tech I always to let, say, a few percentage points go, see the value of RSI when that extreme begin by saying, “With respect to market or even get within 10% of the top or of C is being made. I want to see a bull- analysis, you have three primary disci- 10% of the bottom. Trying to catch the ish divergence. I use my momentum plines: you have quantitative analysis. top is an ego game. Whenever your ego indicators to confirm that this is indeed You have fundamental analysis. And is involved, it never ends well, which is an A-B-C structure. Momentum should you have technical analysis.” what Tharp and Douglas mention in their be decreasing as wave C forms. One of the many benefits of technical works about psychology. Say I have bullish divergence between analysis, because I am looking for pat- I recommend most people to be ex- price and RSI, or price and MACD, or terns, is that I can look at the Australian tremely conservative with their trading. price and MACD histogram. At that point dollar, or the Aussie–New Zealand cross. Depending on what vehicle you trade, it I like to pull in some additional tools, like But within just two or three minutes can be extremely risky. For example, if if I can count five waves down in wave or a few clicks of my mouse, I can be you trade options, that is a highly lev- C, I have divergence. The price move to looking at gold and give you a confident eraged game. It is a complicated game the downside is contained within parallel opinion of the direction of gold. Then because now you have the greeks in- lines, a key characteristic of countertrend with a few clicks on my quote screen, volved — theta, delta, gamma, and time. price action. If I have identified the end I can begin looking at, and give you an You have to be right not just in market or the termination point of wave C, I’d educated opinion on, say, Apple and direction, but also your timing. like to see a bullish engulfing pattern or Google stock. Futures markets are highly lever- maybe a morning star reversal pattern. One of the benefits of technical aged markets and you have to focus When I am applying these different analysis and the wave principle is that on money management, or at least pay disciplines, it helps me build a case. it allows you to go across multiple time heed to it. Think of it this way. You can I can say, “We have a classic five-up, frames and multiple markets quickly. A make $20,000 in a day trading natural three-down from an Elliott wave per- gas because you can lose $20,000 in a spective. I have a bullish divergence, or day trading natural gas. Most people, the appropriate momentum signatures unfortunately, shouldn’t trade because present.” This supports the conclusion they simply do not understand the risks that prices are going to go up. inherent in what is involved. It is easy Then, where I believe that the termi- to lose. You are not always right. That is Reprinted from Technical Analysis of St o c k s & Co m m o d i t i e s magazine. © 2012 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

why risk management is so important. lyst, you are a master of observation. You commodity analyst. My primary focus The big boys, the professionals, the are focusing on what could happen. As is on the commodity markets — that money managers with hundreds of a trader, your primary focus is on what is, the softs, the grains, and livestock. millions, or billions of dollars, follow is happening. Regardless of whether Maybe once a year, I might take a shot the 1% to 3% rule because by being so you think the market’s about to top, if at a commodity. I simply do not trade the conservative in asset allocation, they are the trend is up, as a trader, you’ve got commodities, and the reason is because trading for the long run. They are not to play it. Divergence is a great example I analyze them. I am also a newsletter necessarily trading for the next trade. of what I am referring to. writer, so I write about what I see in the They just want to make sure that they As an analyst, if I am looking at a mo- markets on a daily basis. still have a seat at the table next quarter mentum tool, and I see divergence, well, I don’t like to trade the markets I ana- or next year, because if they can still sit that is suggestive of market weakness. lyze is because I don’t want to be biased. at the table next year they are going to As a trader, I have to focus on what is I don’t want to be bullish in coffee and be able to make a comeback. They are happening, not what could happen. write bullishly about coffee. I don’t want confident of that. They are basically If I see the daily trend is up, I have to overshadow my opinion or my analyt- trading for longevity. to buy the market. How do I resign my- ics simply because I have a position in self to the fact that I have divergence, the market. That way I can sit back and What about the small traders? which means a decrease in momentum, say, “Okay, this is what I see.” I tend to A lot of the time, the small traders tend a possible weakness, and a possible trade individual equities and some of to get excited about the potential profit, trend change? I have to focus on what the exchange traded funds (ETFs). I like so they go all in more frequently. They is happening as a trader and the trend is stocks and primarily trade those either may get lucky two or three times in a up. How do I reconcile that? outright or through options. row, or maybe even five or six times. This is where risk management comes Then there is that one big trade that into play. For example, you are allowed to Trying to figure out Elliott waves often wipes them all out. So they have to step play the buy side to the tune of $100,000. seems to be like a guessing game. What back or sit out for a while until they can If you are seeing divergence begin to happens when you get an A-B-C and put together another trading account and enter the market, you may say to yourself, the C turns out not to be a C and the C go back at it. “I have to trade the trend, and the trend is about 40 yards down the road? Risk management is all about con- is up, but because of this divergence, I It goes back to something simple. sistency. It is all about longevity. It is am not going to go all in.” Remember when I was saying whenever like going back to the story about the So you only go in 50%, or maybe I look for a trade I look for a pattern I rec- tortoise and the hare. You want slow or even 20%, but if you invest as much as ognize? I can go through about 100 stock small consistent profits. I think Mark 75% to 80%, you have to have a very charts looking for a good wave pattern I Douglas in his Disciplined Trader speaks tight stop on the position. That is how recognize. When it comes to trading, it specifically about that — the importance risk management comes into play, and is all about quality, not quantity. When of focusing on small consistent profits how you focus on what is happening and you are looking at a price chart, you are rather than trying to hit a home run every reconcile what is happening as a trader. truly looking for a textbook example. time you get up to bat, or every time you But you also have to take into consider- You are looking for a pattern that jumps take a trade. ation what could happen when you are off the price chart and without question A lot of people have the misconception wearing your analytical hat and see that you know that it is a five-wave up, or a that trading is about making easy money. potential for divergence because there are three-wave decliner. You know that it is There is nothing easy about successful markets I have seen where the divergence a flat or a triangle. trading. It is hard work. Some days I wish continues for six months. Analysts trade The bottom line is when I am looking I had a manual labor job to be guaranteed what could happen, whereas traders trade at a price chart and for an Elliott wave a paycheck. What we do as technicians, what is happening. pattern, I want to be able to identify it professional analysts, and professional within a matter of milliseconds or maybe traders is very hard work. The ones who Given that you follow about 20 com- one or two seconds. If I spend much more are consistently good, year in and year modities and about 150 stocks, which time than that, my mind is wired to look out, tend to be your hardest workers. ones do you mostly trade? for something else. Unfortunately, a lot of people get I don’t trade many commodities at That brings us to another important glassy-eyed about “if I had bought those all. My official gig at EWI is as chief aspect, something I have learned over options then, I could have made 10 times the years. If you are looking at a price my money, or multiplied my money by chart and you don’t see a pattern that you 400% or 500%.” Well, that is true, but recognize (Figure 1), then you look at a you cannot play the “what-if” game. different price chart. You never trade Being an analyst and trader involves gray. You have to know what is going on. two totally separate skill sets. As an ana- You have to see a pattern you recognize. Reprinted from Technical Analysis of St o c k s & Co m m o d i t i e s magazine. © 2012 Technical Analysis Inc., (800) 832-4642, http://www.traders.com INTERVIEW

You trade black. You trade white. But you never trade gray. If there is a doubt, if you don’t see anything that is clear, you move on to something that is. That (A) is one of the things nice about being a C small trader, or what makes trading fun. You can look at 500 different stocks, and (C) out of 500 stocks I can find one wave C pattern that is clear like the one you see B in Figure 2. Having said that, I can look at any price A B chart and give you a wave count. But just A because you can count a price chart or label a price chart, according to the wave principle, doesn’t mean you have a high- A probability trade on your hands. That is a very important distinction between B C academia and the real world. C (D) (B) Thank you for speaking with us, Jeff.

Su g g e s t e d r e a d i n g Appel, Gerald [1985]. The Convergence-Divergence Trading Method, Advanced Version, CQG Figure 1: AN EXAMPLE OF A PATTERN THAT IS UNCLEAR. This market is thinly traded, appears to be working Scientific Investment Systems. a triangle, and the underlying patterns leave a lot to be desired. Bollinger, John [2001. Bollinger On , McGraw-Hill. Douglas, Mark [1990]. The Disciplined Trader: Developing Winning Attitudes, 2 New York Institute of Finance/Simon & Schuster. ii Edwards, Robert D., and John Magee [2001]. Technical Analysis Of Stock Trends, 8th ed., Amacom (first 1 i published in 1948). Frost, A.J., and Robert Prechter [2001]. iv Elliott Wave Principle, John Wiley & Sons (first published in 1985). a Nison, Steve [2001]. Japanese Candlestick Charting Techniques, iii 2d ed., Prentice-Hall Press. b Tharp, Van K. [1999]. Trade Your Way To Financial Freedom, McGraw-Hill. v Wilder, J. Welles [1978]. New Concepts 3 in Technical Trading Systems, Trend 5 Research. ‡CQG

Figure 2: AN EXAMPLE OF A PATTERN THAT IS CLEAR AND TRADABLE. MGM is unfolding in five waves from this year’s high. Subsequent price action is wave 5 and should continue to near $8.00.