Posted on September 10th, 2009 at 11:30 AM

In An outlook on Crude Oil we took a look at the Elliott Wave count and talked a little about how to adjust the count as well as the reasons behind the adjustment.  Today I want to take a different approach to our analysis by using the False Bar Stochastic Study and explain why there are differences in the analysis and why even with the differences they are both correct ways to look at the chart and trade.

First you need to understand why the Elliott Wave Counts and the False Bar Stochastic Study can sometimes contradict each other.  In Advanced GET our Elliott Wave uses a default of 300 bars to display the current wave count.  Out of all of our strategies Elliott Wave uses the largest amount of bars in it's calculation, this usually gives you the long term patterns to trade.  On the other hand the Stochastic Study can range in it's calculation from 14 bars (It's a 14 bar Stochastic) all the way to an unlimited number of bars depending on the trend length.  Although from my experience I would venture to say that the Stochastic typically takes into account no more than 40 bars in a given market swing.

Now think about that.  Elliott is looking for trends, retacements, continuations over a 300 bar pattern.  Stochastic is only using roughly 14-40 bars in it's calculation to find trends and retracements.  Obviously the Stochastic is looking at shorter term directional patterns then Elliott Wave.  This is why (and this one of the most common questions I get during mentoring and through follow-up email's) that when Elliott says the market is at the end of a five wave sequence the False Bar Stochastic can still say the market is trending.  You are looking at the difference between a 300 bar pattern and a 14-40 bar pattern.  Of course they are going to be different!

Take a look at the current chart of Crude Oil and you can see that exact scenario taking place.

Using our updated count Crude Oil has reached a new Wave 5 high indicating a sell off is approaching, if you recall yesterday's blog we talked about the entry and the first profit level which was hit before being stopped out in our recent rally.  Now take a look at the False Bar Stochastic indicator.  While Elliott is hinting at a market correction the False Bar says, "Wait!!!  We are still in a trend and you should be long!"  The difference?  300 bars vs. 14-40 bars.  While we are overall looking at a possible reversal, the short term strategy treats this as a new trend because as far as the Stochastic knows the data from before July does not exist, it's simply not taken into the calculation.

What should the trader do?  If you are a beginner who is still looking to build confidence in your trading I would recommend ignoring the False Bar indicator during a Wave 5 sequence.  You now know that it's a short term indicator and will often contradict the Elliott Wave in the fifth wave and I would recommend staying with the longer term market looks as ultimately over time the longer term patterns often win out.  Even if crude oil reaches new highs the Wave 5 pattern still is in place, we just simply had a false breakout.

In my trading I approach these patterns like this.  I always trust the Elliott Pattern first and foremost and my trading decision here would be to take the Type II trade and ignore the Stochastic.  However, if for some reason I miss the original Type II entry, perhaps I was not watching Elliott, or maybe I was watching another chart at the time, whatever the reason.  I will take the corresponding False Bar Stochastic Trade even though I know that Elliott is against it.  Here is my logic.

After a the Wave 5 high Crude Oil has begun to fall as we expected.  As I showed in yesterdays blog we sold off to an Ellipse Level which acted as our first profit target for the Type II.  If you missed that trade notice how the Stochastic has hit 25 right at our support level.  Now in a perfect world we would be below 25 like we were back in July, but as long as we touch 25 we can justify the trade.  This rally could be our Elliott Wave 2 forming before our ultimate drop of Wave 3.  If you are aggressive at taking profits in your trades this Wave 2 rally could return a nice profit even if we never reach new highs.  Let me stress what I wrote earlier, this trade is only taken if you did not take the original Type II trade.  This new setup is simply a consolation prize for us late comers to the market.  On another note, I would not recommend a stop and reverse strategy.  In other words don't exit your Type II and then try and buy into the Stochastic Trade, let the original Type II play out.

At the end of the day how did these two methods of analysis play out?  On the Type II Sell you would have hit the first level of profits and then stopped out for a winning trade.  In the shorter term Stochastic look you would be profitable and in money management mode adjusting your position as the market attempts to make a new high in the coming days.  Both methods returned profitable trade scenarios, and as far as I am concerned that is all that matters.

Ron Wheeler

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