As indicated in my momentum thread at http://forums.babypips.com/show-me-money-daytrading/45823-saigonfxs-daily-short-term-momentum-strength-scores.html, my trading system has today issued a sell signal for AUDUSD. Here are the trade specs:
Selling AUDUSD at current price of 1.0317 (risking 0.4% of my equity)
Stop: 1.0510
Limit: 1.0110
Should price get to 1.0376, I will add a further short in which I risk an additional 0.6% of my equity.
Should price get to 1.0435, I will add a further short in whicih I risk an additional 1% of my equity.
Total possible equity risked in the entire trade setup is 2%.
Note that risk/reward ratio starts at 1:1 but goes higher should price move higher. Here is the trade setup in graphic form:
To get a handle on why this might be a good trade to take, let’s start with the long-term picture going back to 2008. In Elliott Wave terms, the market seems to be tracing out a classic five-wave advance. Within that advance, as Elliotticians would expect, wave IV (a corrective wave) is looking like it is tracing out a triangular consolidation pattern. I believe we are now in the fourth (or “D”) wave of that triangular pattern and are preparing to enter the fifth (“E”) wave, which will be a decline to around .9700.
If we zoom in on the triangle, we see that waves A, B, and C each advanced in 3 waves, often very choppily so with huge swings in price. Wave D has not been so wildly choppy but then again it is still in progress so that could change. A very common Fibonacci relationship in triangular corrections is that Wave D travels approximately 61.8% of the distance travelled by Wave B. If we measure the waves, we see that Wave B traveled 1463 pips. 61.8% of 1463 pips is 904 pips. Because wave D began at .9584, that gives us a target price for Wave D at 1.0491.
However, if we zoom in further on the structure of Wave D, it appears to be forming to weakly that it will never reach this target. If wave D travels 50% of wave B (another common Fibonacci ratio), that would give us a target price of 1.0316, which we’ve seen in today’s trading. The structure of wave D so far seems to be, in Elliott terms, a-b-c-X-a-b-c, in EWT called a “double-three” formation. It’s possible that if price wants to move higher to the 1.0491 neighborhood highlighted on the weekly chart, price could form another X-wave followed by another anemic a-b-c advance, but momentum readings are suggesting against this possibility. A more likely target for the end of wave c in the chart below is 1.0368, which is the point where the second a-b-c formation will equal 61.8% the distance of the first a-b-c formation. I anticipate that when wave c completes this week, price will reverse to retrace at least the entire advance from 1.0100.
On the short-term chart, we see that momentum has turned strongly bearish in the current wave c rally. In terms of time, I anticipate wave c to terminate by the end of this week.
In cases like these, when momentum over multiple time frames is consistently bearish and price seems to be tracing out a terminal Elliott Wave pattern, my basic conditions for entering trade are met.
From a risk management perspective, I recognize that price could very well continue upward to hit the Fibonacci target of 1.0491, however, and that is why I am beginning this trade with an initial entry that risks only 0.4% of my equity. If price rises higher to 1.0376, I am prepared to risk another 0.6% of my equity. And if price rises further to 1.0435, I will risk another 1% of my equity. The rationale for risking increasing amounts of equity as price travels contrary to the direction of my trade is that if price does so, it is only becoming increasingly likely (from a probability perspective) that the trend is about to reverse. The lower risk inherent in such probability justifies applying greater leverage in my trading system.