The strategies we use in our portfolio are purely quantitative, i.e. they follow a specific set of rules to identify risk on and risk off conditions that we then use to determine our exposure to the market on a given day, 

There is another interesting approach to analyse the markets that is somehow less objective despite having its own set of rules and guidelines. We are talking about Elliott Wave Theory. 

There is often a lot of confusion about how to use Elliott Wave Theory when trading and it mostly come from the fact that people tend to have the wrong expectations about this tool. What needs to be understood is that this approach won’t give us one prediction about future market direction but many.

The rules and guidelines are extremely helpful to identify a list of plausible scenarios but will never be able to reduce such list to just one scenario. 

So is it of any use then? Definitely yes, because being able to identify a set of plausible counts that describe the current market environment and how it can evolve in the future is extremely important when taking trading decisions.   

Let’s look at one example. This is our current Elliott Wave count on SPY. What we show here as dotted lines (red and white) are expected future paths for the price based on what we consider being the most likely count at this point. 

As we can see, in the short term we expect the market to either go up or down… not very helpful for now. But with Elliott Wave Theory we need to have a plan and we won’t decide to enter long or short at this point without first having a confirmation from the market.  

But in the medium term both the red and white path point down, so can we go short with that horizon in mind? If that is your primary count then yes, that’s a possibility. But when building the exposure we should always take into consideration other possible counts in order for us to understand at what point our initial “primary count” becomes less likely and we should shift our view and adjust our position accordingly. 

For example, the following count is also a possibility at this point in time. Whoever wants to go short with a medium term horizon must take this into consideration.  

In our “Option Strategist” series we have covered many adjustment to option strategies and we believe that type of activity would benefit greatly from a Elliott Wave type of analysis. Deciding how to adjust a position and when is what Elliott Wave Theory can help you to decipher. 

But the information presented in this document can be used by any trader who wants to learn how to read the markets, not only those using options.