Wolfe Wave Reversal

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The Wolfe Wave Critique by BeginnerTrader

 

wolfe wave

The Bullish & Bearish Wolfe Waves - Taken from Bill Wolfe's Book

You can see from these basic example charts, that a Wolfe Wave is essentially an ascending or descending wedge depending on the market conditions. For a wedge to be called a Wolfe Wave it must consist of four waves with the end of the fourth wave (marked 5 in the above charts) reaching, or exceeding the wedge pattern extremes.

EPA stands for Estimated Price at Arrival, which doubles as your profit taking line.

ETA, stands for Estimated Time of Arrival (and should be completely ignored, even Wolfe himself acknowledged this, which makes you
wonder why he mentioned it at all really?). Wolfe's basic premise for trading these patterns is to wait for point 5 to enter a trade, and look for the line marked EPA to be your target.


Looks wonderfully easy in hindsight doesn't it. So why do they work (sometimes)? Wolfe waves work on the psychological frailty of the novice trader. The best Wolfe waves tend to be those that are pointing in the
direction of the established trend. 

Trends are wonderfully easy to find after they have confirmed themselves with three to four waves. Before that they look like a standard retracement in the previous trends direction. It is only after that retracement fails, that a new trend is suspected, and once a new high/low is set in the opposite direction, it is then we can think a new trend is has formed. 

The professional/experienced trader can usually find signs of these developing trends earlier and jump on the departing train. The inexperienced trader, needs multiple confirmations, before they agree a trend is in place. The result being increased pressure on the retracements in the final stages of the trend from the late arrivals, meanwhile the big money slowly jumps of the impending train wreck, meaning shallower proportional breaks of new highs and lows. 

Really the Wolfe wave is no more than a technique to trade a matured wedge pattern, telling you where to enter, and where to look to take profits. The entry is based on the concept of a final exhaustive run in the direction of the trend, using up the last of the buyers/sellers. Price then reverses suddenly and heads off towards the EPA, which hold similar concepts to the Axis lines I talked about in a previous article. 

So how do you trade it. To trade a Wolfe wave consistently you need to recognise the inherent weakness of the
technique itself, that is; 

1. You are trying to catch a falling knife.
2. You are entering after a new high or low has been made, making identifying entry locations difficult.
3. Your trip to your target is against the previous trend .. making it a bumpy ride at times as people get out
of positions.

 
Written by: BeginnerTrader
The Wolfe Wave (Not to be confused with The Elliot Wave), discovered by Bill Wolfe, is a naturally occurring, harmonic trading pattern and is generally seen as a reversal pattern. The pattern is made up of five waves (fives distinctive bull & bear movements within a channel) showing supply and demand and the fight between supply and demand towards setting a new price. These patterns can develop over short and long-term time frames such as minutes or weeks and are used to predict where a price will break-out of it's channel and where price will go after the break. When correctly exploited, Wolfe Waves can be extremely effective. 

It's Reversal Qualities
An upward sloping trending channel will result in a bearish reversal of price and a downward sloping trend channel will result in a bullish reversal of price. 

Generally the Wolfe wave can be seen when the price is contained within a channel and can give traders a good idea when the price is going to break-out of the channel and reverse.  These channels can be parallel as per our Range and Channel Trading section, or can converge as per Wedge Patterns.  Within these channels the Wolfe Wave has an amazing symmetrical pattern, with the wave cycles having equal time intervals between them.  This symmetry can be seen in our QQQQ chart below.

QQQQ. Bearish Wolfe Wave Example

A Bearish Wolfe Wave
When charting the Wolfe wave the channel is formed by the end points of waves 1 to 3 - i.e points 1, 2, 3 & 4. Once we have these peaks and troughs we draw our trend lines.  In our example they are converging, but in many cases they are parallel, or diverge.  Now wave 4 (between points 4 & 5) can either be contained within this channel or over-shoot, as seen in our example. In any event wave 5 will re-enter the channel and then head towards a target "equilibrium" (Wolfe's word)  price level. We'll talk about this target more later. As shown in the our 5 minute QQQQ chart, the most accurate patterns exist where there are equal time intervals between wave cycles (1, 3 & 5).  Our example above is an up trend channel forming a bearish Wolfe wave.  

The Wolfe Wave's Psychology
Bill Wolfe suggests that the wolf wave is a naturally occurring harmonic pattern, found in all financial charts, all of the time.  This suggests that there's no psychology behind it.  If you want to get to grips with the psychological mindset of the market, then other technical analysis will have to be utilised.  For instance the use of volume, support & resistance and price action may be useful in understanding the market's psychological state.  Of course, Bill Wolfe and his disciples would be against the use of additional indicators, as Wolfe suggests that the Wolfe Wave stands alone in it's methodology. The choice is yours...

The key points of The Wolfe Wave
Below I've listed the key points traders look for when identifying the pattern, developing it and eventually playing it
  • A channel is formed by waves 1 to 3 - points 1, 2, 3 & 4
  • There should be regular timing intervals between waves (showing symmetry).
  • Waves 3 and 5 are usually 127% and 162% Fibonacci extensions of the previous channel point. Fib extensions will be discussed in later modules.  Our example almost hit these levels.
  • Point 5 is a move slightly outside the channel - A channel created by points 1 to 4. This move is usually a false price breakout.  It's best to enter a market once price moves back within the channel (The false move doesn't always happen).
  • The point after wave 5 is the target level. The target price is found by connecting points 1 and 4 and extending it - as per the red line above.  By using symmetry we can pin point this target.
  • A rising channel will form a bearish Wolfe wave, i.e support will be broken to achieve target at 6.
  • A falling channel will form a bullish Wolfe wave breaking upper resistance to achieve a bullish target.
  • Horizontal channels during consolidation periods mean the break can go either way.
Trading the Wolfe Wave
Both the bear example and the bull Wolfe wave are traded in exactly the same ways . You’ll notice in our above QQQQ example point 5 overshoots resistance in the bearish Wolfe wave. When wave 5 overshoot support or resistance the returns to the channel this is known as a false price breakout. The break-out line indicates the ideal place to enter the trade. 
  • Enter the trade after wave 5 re-enters the channel at $46.82.  Entering on re-entry confirms the pattern.
  • Our stop/loss can be placed just above resistance, or above point 5.  Let's place it above point 5 to give our trade room to breathe and develop.  Stop/loss placed at $46.9 for a potential loss of 0.08 per share
  • Draw a line between points 1 and 4
  • Anticipate this line to a target at $46.62.  Use symmetry to anticipate a target.  I.e the target should have the same time symmetry as points 2 and 4
  • Potential profit = 0.2 per share
  • Profit to Loss ratio = 0.2 : 0.08 = 2.5 : 1
The Bullish Wolfe Wave
The bullish wave (i.e, a Wolfe wave forming in a down trend) will form as a mirror image of our above QQQQ example.  In the below Bullish Wolfe Wave example, Points 1 and 3 will form support and points 2 and 4 form resistance.  Point 5 will overshoot support with a target point (6) forming above the channel.

Bullish Wolfe Wave Example

To Sum Up
It is important to note that Wolfe Waves, are highly subjective and may need other technical analysis to figure out the market psychology (although Bill Wolfe, probably wouldn't agree with the use of further TA).  The key to profiting is accurately identifying and exploiting these trends in real time, which can be more difficult than it sounds. As a result, it is wise to trade this technique with a practice account - as it is any new technique you are learning - before going live. And, remember to use stop/loss to limit your losses.

Technical analysis is not an exact science and although these indicators and patterns can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

In Bill Wolfe's own Words

Why does the WolfeWave work so well? Market timing is not about finding the Holy Grail. Market timing is not about complicated algorithms. Market timing is not about colorful indicators and oscillators. Market timing is about BALANCE.

An Example:
We're at the 5 point and the market just opened. TV has been telling traders that the market is going to have a "great day" because Globex is up and the market is sure to open higher. How many times have you heard it? How many times has it failed? WolfeWave practitioners giggle. They know that the market is now out of balance and will soon correct to the downside, big time!
Two hours later: Price hits WolfeWave target line.


Bill Wolfe Example - Click to Enlarge

The Wolfe Wave isn't subjective. The reason one might suspect subjectivity after viewing the examples is because they are not privileged to the precise set of rules. Another misconception may be is that Waves are random. Not so. There is ALWAYS a Wave in progress. It is IMPOSSIBLE for there to be motion without a Wave rhythm.

The Wolfe Wave is a "stand alone" methodology.  The Wolfe Wave doesn't use traditional chart patterns or indicators.

Written By Bill Wolfe

=======

The Wolfe Wave Critique by BeginnerTrader

 

wolfe wave

The Bullish & Bearish Wolfe Waves - Taken from Bill Wolfe's Book

You can see from these basic example charts, that a Wolfe Wave is essentially an ascending or descending wedge depending on the market conditions. For a wedge to be called a Wolfe Wave it must consist of four waves with the end of the fourth wave (marked 5 in the above charts) reaching, or exceeding the wedge pattern extremes.

EPA stands for Estimated Price at Arrival, which doubles as your profit taking line.

ETA, stands for Estimated Time of Arrival (and should be completely ignored, even Wolfe himself acknowledged this, which makes you
wonder why he mentioned it at all really?). Wolfe's basic premise for trading these patterns is to wait for point 5 to enter a trade, and look for the line marked EPA to be your target.


Looks wonderfully easy in hindsight doesn't it. So why do they work (sometimes)? Wolfe waves work on the psychological frailty of the novice trader. The best Wolfe waves tend to be those that are pointing in the
direction of the established trend. 

Trends are wonderfully easy to find after they have confirmed themselves with three to four waves. Before that they look like a standard retracement in the previous trends direction. It is only after that retracement fails, that a new trend is suspected, and once a new high/low is set in the opposite direction, it is then we can think a new trend is has formed. 

The professional/experienced trader can usually find signs of these developing trends earlier and jump on the departing train. The inexperienced trader, needs multiple confirmations, before they agree a trend is in place. The result being increased pressure on the retracements in the final stages of the trend from the late arrivals, meanwhile the big money slowly jumps of the impending train wreck, meaning shallower proportional breaks of new highs and lows. 

Really the Wolfe wave is no more than a technique to trade a matured wedge pattern, telling you where to enter, and where to look to take profits. The entry is based on the concept of a final exhaustive run in the direction of the trend, using up the last of the buyers/sellers. Price then reverses suddenly and heads off towards the EPA, which hold similar concepts to the Axis lines I talked about in a previous article. 

So how do you trade it. To trade a Wolfe wave consistently you need to recognise the inherent weakness of the
technique itself, that is; 

1. You are trying to catch a falling knife.
2. You are entering after a new high or low has been made, making identifying entry locations difficult.
3. Your trip to your target is against the previous trend .. making it a bumpy ride at times as people get out
of positions.

 
Written by: BeginnerTrader
The Wolfe Wave (Not to be confused with The Elliot Wave), discovered by Bill Wolfe, is a naturally occurring, harmonic trading pattern and is generally seen as a reversal pattern. The pattern is made up of five waves (fives distinctive bull & bear movements within a channel) showing supply and demand and the fight between supply and demand towards setting a new price. These patterns can develop over short and long-term time frames such as minutes or weeks and are used to predict where a price will break-out of it's channel and where price will go after the break. When correctly exploited, Wolfe Waves can be extremely effective. 

It's Reversal Qualities
An upward sloping trending channel will result in a bearish reversal of price and a downward sloping trend channel will result in a bullish reversal of price. 

Generally the Wolfe wave can be seen when the price is contained within a channel and can give traders a good idea when the price is going to break-out of the channel and reverse.  These channels can be parallel as per our Range and Channel Trading section, or can converge as per Wedge Patterns.  Within these channels the Wolfe Wave has an amazing symmetrical pattern, with the wave cycles having equal time intervals between them.  This symmetry can be seen in our QQQQ chart below.

QQQQ. Bearish Wolfe Wave Example

A Bearish Wolfe Wave
When charting the Wolfe wave the channel is formed by the end points of waves 1 to 3 - i.e points 1, 2, 3 & 4. Once we have these peaks and troughs we draw our trend lines.  In our example they are converging, but in many cases they are parallel, or diverge.  Now wave 4 (between points 4 & 5) can either be contained within this channel or over-shoot, as seen in our example. In any event wave 5 will re-enter the channel and then head towards a target "equilibrium" (Wolfe's word)  price level. We'll talk about this target more later. As shown in the our 5 minute QQQQ chart, the most accurate patterns exist where there are equal time intervals between wave cycles (1, 3 & 5).  Our example above is an up trend channel forming a bearish Wolfe wave.  

The Wolfe Wave's Psychology
Bill Wolfe suggests that the wolf wave is a naturally occurring harmonic pattern, found in all financial charts, all of the time.  This suggests that there's no psychology behind it.  If you want to get to grips with the psychological mindset of the market, then other technical analysis will have to be utilised.  For instance the use of volume, support & resistance and price action may be useful in understanding the market's psychological state.  Of course, Bill Wolfe and his disciples would be against the use of additional indicators, as Wolfe suggests that the Wolfe Wave stands alone in it's methodology. The choice is yours...

The key points of The Wolfe Wave
Below I've listed the key points traders look for when identifying the pattern, developing it and eventually playing it
  • A channel is formed by waves 1 to 3 - points 1, 2, 3 & 4
  • There should be regular timing intervals between waves (showing symmetry).
  • Waves 3 and 5 are usually 127% and 162% Fibonacci extensions of the previous channel point. Fib extensions will be discussed in later modules.  Our example almost hit these levels.
  • Point 5 is a move slightly outside the channel - A channel created by points 1 to 4. This move is usually a false price breakout.  It's best to enter a market once price moves back within the channel (The false move doesn't always happen).
  • The point after wave 5 is the target level. The target price is found by connecting points 1 and 4 and extending it - as per the red line above.  By using symmetry we can pin point this target.
  • A rising channel will form a bearish Wolfe wave, i.e support will be broken to achieve target at 6.
  • A falling channel will form a bullish Wolfe wave breaking upper resistance to achieve a bullish target.
  • Horizontal channels during consolidation periods mean the break can go either way.
Trading the Wolfe Wave
Both the bear example and the bull Wolfe wave are traded in exactly the same ways . You’ll notice in our above QQQQ example point 5 overshoots resistance in the bearish Wolfe wave. When wave 5 overshoot support or resistance the returns to the channel this is known as a false price breakout. The break-out line indicates the ideal place to enter the trade. 
  • Enter the trade after wave 5 re-enters the channel at $46.82.  Entering on re-entry confirms the pattern.
  • Our stop/loss can be placed just above resistance, or above point 5.  Let's place it above point 5 to give our trade room to breathe and develop.  Stop/loss placed at $46.9 for a potential loss of 0.08 per share
  • Draw a line between points 1 and 4
  • Anticipate this line to a target at $46.62.  Use symmetry to anticipate a target.  I.e the target should have the same time symmetry as points 2 and 4
  • Potential profit = 0.2 per share
  • Profit to Loss ratio = 0.2 : 0.08 = 2.5 : 1
The Bullish Wolfe Wave
The bullish wave (i.e, a Wolfe wave forming in a down trend) will form as a mirror image of our above QQQQ example.  In the below Bullish Wolfe Wave example, Points 1 and 3 will form support and points 2 and 4 form resistance.  Point 5 will overshoot support with a target point (6) forming above the channel.

Bullish Wolfe Wave Example

To Sum Up
It is important to note that Wolfe Waves, are highly subjective and may need other technical analysis to figure out the market psychology (although Bill Wolfe, probably wouldn't agree with the use of further TA).  The key to profiting is accurately identifying and exploiting these trends in real time, which can be more difficult than it sounds. As a result, it is wise to trade this technique with a practice account - as it is any new technique you are learning - before going live. And, remember to use stop/loss to limit your losses.

Technical analysis is not an exact science and although these indicators and patterns can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

In Bill Wolfe's own Words

Why does the WolfeWave work so well? Market timing is not about finding the Holy Grail. Market timing is not about complicated algorithms. Market timing is not about colorful indicators and oscillators. Market timing is about BALANCE.

An Example:
We're at the 5 point and the market just opened. TV has been telling traders that the market is going to have a "great day" because Globex is up and the market is sure to open higher. How many times have you heard it? How many times has it failed? WolfeWave practitioners giggle. They know that the market is now out of balance and will soon correct to the downside, big time!
Two hours later: Price hits WolfeWave target line.


Bill Wolfe Example - Click to Enlarge

The Wolfe Wave isn't subjective. The reason one might suspect subjectivity after viewing the examples is because they are not privileged to the precise set of rules. Another misconception may be is that Waves are random. Not so. There is ALWAYS a Wave in progress. It is IMPOSSIBLE for there to be motion without a Wave rhythm.

The Wolfe Wave is a "stand alone" methodology.  The Wolfe Wave doesn't use traditional chart patterns or indicators.

Written By Bill Wolfe

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