Trading with the Wave
By Raghee Horner, Founder / Lead Trader of EZ2TradeSoftware.com and Author*
Posted: Apr 21, 2006

Maybe it's because I like to surf that I call my favorite trading tool the "Wave". The Wave is created by three, 34-period exponential moving averages, one on the high, one on the low and one on the close.

Being a chartist means that I rely on charts and price action for all of my entries and exits and that I use support and resistance. Early on in my trading career, I would often find myself on the wrong side of the lines and levels on my chart -- whether those were trendlines or support and resistance levels.

One common scenario would have me trying to decide whether to be long just beyond resistance or to short the resistance level. I mean, we've all read that we can short prices as they approach resistance, or we can go long as price breaks above it. While that sounds good, it will often lead to whipsaws, which, in turn, will erode the confidence any mortal would have in his or her charts and charting skills. And, confidence is the most important asset of any trader!

I needed a way to determine in advance which resistance or support levels I would wait to see break and which would make more sense to play on a reversal.

The chart of the 180-minute Australian dollar / U.S. dollar (symbol: aud a0-fx) is moving sideways. I know this because the Wave is traveling at three o'clock. I use "clock angles" to determine the direction and strength of the Wave. An uptrend is when the Wave travels up between 12 and two o'clock and a downtrend is between four and six o'clock.

The Aussie is range-bound between the 0.250 and 0.786 Fibonacci levels. A symmetrical triangle has also formed. Because the Wave is traveling sideways (three o'clock), I am going to wait for a momentum set-up. Momentum set-ups are breakouts and breakdowns through trendlines, support or resistance.

When the Wave is traveling down between four and six o'clock, as in the next example, we can see that prices are trading lower. In any "trade-able" trend, there will be corrections. The key here is corrections within an established trend. It is as easy as looking at the Wave to determine whether prices are trending up or down. Take a clock angle trade!

Trading corrections within an established trend is swing trading. We are entering on the "swings" or, more specifically, measured moves. These measured moves are bounces and pullbacks. The way we measure what a measured move is by using the Wave or Fibonacci levels. When prices are upward at a 12-to-two o'clock Wave, I will wait for prices to pull back to either a Fibonacci level (aggressive) or to the Wave itself (conservative).

The two arrows show two conservative opportunities to short this market. The main goal is to wait for a correction within the trend. Keep in mind that almost every trend started with a breakout or breakdown from a sideways market (three o'clock Wave), so a trend is a continuation from the original momentum trade.

The daily chart of the Eurodollar / U.S. dollar (symbol: eur a0-fx) has broken out in textbook fashion from a momentum set-up: Three o'clock Wave and triangle pattern. The breakout was the beginning of what may become a trend. Note that the Wave is now in transition from the sideways clock angle to potentially a 12-to-two o'clock angle. If this does happen, we can then say that the EUR / USD is trending.

This will change the type of entry we will be looking for to a swing-trading set-up, and, then, we'll sit back and wait for pullbacks to either the Wave or a Fibonacci level.

*Reprinted (and modified) with permission from Raghee Horner of EZ2TradeSoftware.com