Trade “Middle Waves” For a High Probability of Success

A common trading problem is that if you wait too long to enter a trade–until everything looks perfect–the trend is likely almost over. Yet, if you try to anticipate changes in direction you’ll likely be too early and thus sustain losses before the market turns in your favor. If Goldilocks were a trader, she wouldn’t want to enter too early or too late, she’d want a trade right in the middle. That’s where the bulk of the money is, and where new traders should place most of their focus.

Finding the Middle

In trading circles, the middle of the trend is often referred as “the 3rd wave,” related to the Elliott Wave Theory assertion that trends typically unfound in 5 wave patterns, and then correct in 3 wave patterns as shown in figure 1.

Figure 1. Basic Elliott Wave Structure

Trading middle waves doesn’t require any Elliott Wave knowledge, because by looking for a certain pattern most trades will end up taking place during “wave 3,” or even if we don’t realize we are in a pullback and not a trend, worst case scenario we are trading in “wave c.” In either case, the setup aligns in the right direction to profit from wave 3 or wave C.

The Set-Up

To find the middle of an uptrend, you need a higher high and a higher low.

To find the middle of a downtrend, you need a lower low and a lower high.

Figure 2 shows the start of an uptrend. The AUD/USD had been moving lower, making lower lows and lower highs. Then, on a strong rally it makes a higher high followed by a higher low. This provides a high probability that the trend has shifted–at least temporarily.

Figure 2. AUD/USD Shift in Trend – Daily Chart

In this case, after the higher high, we need to wait for a pullback. As long as the pullback stays above the prior low we are looking for a long trade, because we now have a higher-high and higher-low, which means either a wave 3 (preferably) or wave c is about to unfold and we want to be a part of it.

Figure 3. Setup

Figure 3 shows the basic set-up. Based on the higher-higher, we want to go long, but need to wait for a pullback to do so. We let the pullback materialize, but as soon as the price starts moving higher again we take a long position. Figure 3 shows an entry point where a very strong up bar moves above the highs of prior pullback-bars, indicating the buying is resuming.

A stop loss is placed just below the most recent low on the current pullback (or above the recent high on the current pullback if looking to go short in a downtrend).

At the very far right of the chart the price reversed again, therefore this “trend” only lasted 3 waves and not 5. By trading this strategy though it doesn’t matter; since markets almost always move in at least 3 waves, often more, by getting in just as the third wave (or wave c) is starting the trade has a high likelihood of at least moving somewhat in our direction before reversing.

With binary options your profit is already set, but for those trading traditional markets, a Fibonacci Extension tool can be used.

If the pullback is relatively shallow compared to the prior wave, as it is in Figure 4, exit at the 61.8% extension. If the pullback is quite deep (retraces more of the prior wave) then use the 100% extension level. As a general rule, use the first extension level which is above the prior high in an uptrend, as shown in Figure 4 (or below the prior low in a downtrend). The rectangle at the 61.8 level indicates the exit.

Figure 4. Target

Final Word

This strategy takes advantage of what appears to be the middle of a trend. There is no way to know for sure when the trade is taken that it will work out. The market does produce repeating patterns though (even though they may look slightly different each time), therefore many traders seek out these middle or 3rd waves because of their “trustworthiness.” A strategy that covers how to enter the trend sooner is covered in The High Probability Snap-Back Strategy.