Buying Stocks On Margin

The past few years may have been tumultuous ones for your investment portfolio, but stocks and other financial instruments have since recovered much of their value. At times like these, you may begin to ask yourself if there are ways to increase the return on your investment. Borrowing money to leverage your investments is one way to do this.  But is it a good idea?

Sources of Funds to Buy Stocks on Margin:

When you borrow money with the intent of plowing it into an investment, you’re said to be “increasing your leverage.” Just like using a “Lever” to lift a heavy object… financial leverage can use a small amount of cash to do the work of much more capital.  The following are some common sources of leverage.

• Home-equity loans- Since the stock and bond markets are inherently risky, it’s unlikely that you’ll be able to walk into a bank and request a loan to increase your leverage in those arenas. It is possible, however, to take out a Mortgage against the value of your house for virtually any purpose. Many risk-takers who spot a golden opportunity in the market use home-equity loans or lines of credit to leverge their investments.
• Margin accounts- As long as your brokerage account exceeds a minimum threshold, your broker will allow you to borrow a certan amount of money from them to increase your investing power. Margin accounts come with strings attached, like interest rates several points above prime and borrowing limits of 30 to 50 percent of the size of your portfolio.
• Short sales- This can be a quick, profitable way to increase your buying power, but it’s also quite risky. To short a stock, you borrow its shares from your brokerage firm and sell them at a set price. If the stock price falls, you can buy them back at the lower price and return them to your broker, pocketing the difference.
• Options- Options are contracts which allow you to put down a small amount of money and control a larger number of shares for a limited amount of time thus providing excellent leverage for the time that the option is valid.
• Leveraged Funds- Buying leveraged Mutual Funds or Exchange Traded Funds (ETFs). Some funds are intrinsically leveraged providing 2X or even 3X the movement of the underlying index.

Benefits of Investing Borrowed Funds

Using leverage to goose your returns in the Stock Market can seem like a smart move when your investments do well. It’s possible to double your money in weeks or months by shorting a distressed stock near the top of its plunge and buying it back near the bottom. If you’re more conservative with your money, you can still reap the rewards of leverage by using a margin account to buy 50 percent more of a stock that looks to be on the way up. When you’ve made a tidy profit, simply sell the borrowed shares and repay your broker.

Drawbacks of Buying Stocks On Margin

Where there is increased reward, there’s usually also increased risk. The most common mistake you can make as with leveraged Investing is to forget that leverage cuts both ways. Investors can make more when the value of their shares is increasing but they will also lose more when the market turns against them. If you sell a stock short before it increases in value it can leave you in serious debt to your broker. If you buy on margin, don’t forget you have to repay your broker for the borrowed shares or funds unless you want to lose 5 to 10 percent of your portfolio to interest charges each year. Remember, investment debt can be a trap, just like any other form of credit. Holding it for too long can seriously affect your credit score.

If you’re a savvy investor, borrowing money for your investment portfolio can leverage your returns and put you in a great financial position. It can also be devastating to your finances and overall credit situation if you make a bad call or borrow more than you can afford to lose. Make an informed risk-reward calulation based on your financial situation before deciding whether to take the big step of Buying Stocks On Margin.

Guest author Jeffery Hackett is a self proclaimed financial guru and freelance blogger writing on behalf of www.paydayloans.org.uk.

Investing for Retirement

One of the biggest worries about retiring is the question of how to fund your living expenses for the duration of your retirement period. Most people do the basic thing which is to invest in a pension plan through their employer. If you don’t already have a workplace pension in place and are over a certain age and earn more than a set amount, then your employer may automatically enroll you for a workplace pension but investing for retirement deserves more planning and thought than that.

Advantages of Employer Sponsored Pension

The advantages of investing in an employer sponsored pension are numerous.

For one thing, your employer will contribute to it, and so will the government via tax deductions/credits for your contributions. In other words some of the income tax that you would have paid just goes right back into your pension fund instead of the government’s coffers. Plus this pension will always be yours, regardless of whether you leave your employer in the future. While doing this can help you cover your living expenses when you retire, the simple fact is that it may not be enough for everything that you want. Depending on your contribution level, an employer sponsored pension   may be just enough to become a hand to mouth experience for every month. In old age, you would most likely prefer to live more comfortably than that so let’s look at some additional alternatives…

Alternatives to Employer Sponsored Pensions

Investing in annuities is another option. The concept is a simple one. What happens is that you enter into an agreement with an Insurance company. You agree to pay them a lump sum of money or make regular payments and the insurer then gives you a fixed amount of money every month after your retirement.

The advantage is that you can’t outlive your retirement income, so even if you live to be over 90 or even a hundred years of age, the insurance company has to keep on paying you. Thus you might end up getting a whole lot more than what you paid them. On the other hand, if you only live a couple of years after retirement, the insurer keeps the money balance. Be sure to invest with a reputable insurance company and you can depend on a regular income when your retirement comes. This makes annuities a good complement to other retirement plans.

See Is a Retirement Annuity the Answer for your Retirement Savings? for more information.

Another type of annuity is called a variable annuity. What happens is that you pay in capital for a variety of investments that you choose yourself. In this case, once you start receiving the payout, you continue to receive payments until the principle is used up. So there is no guarantee that it will last your entire lifetime. But the insurance company who you have partnered with will give you certain guarantees known as riders over that portfolio. Some of these annuity products come with very attractive riders. Including a “lifetime income rider”.

Bonds are another good choice for investing money for your retirement. Buying a Bond means that you are essentially giving the government or a company a loan. You are paid interest on the bond for a certain period of time and when it reaches maturity, your principal sum is paid back to you. It is the interest itself that becomes a steady source of income.

See: Invest in Structured Bonds?, What are Company Bonds?

Real Estate- You can invest in property if you have the funds and then rent it out. During your working life the tennant helps to pay off your mortgage and then hopefully, in retirement, the mortage is paid off and the rent payment is pure income. This is an excellent way to ensure that you get an extra income every month as long as you have a good tenant. However, just like every other investment, real estate does have some disadvantages too. You as the landlord will be responsible for all maintenance costs and there may be other unforeseen expenses as well. However a good portfolio of investment properties can be a real boon in retirement. If you would like the advantages of real estate investment without the headaches you can invest in Real Estate Investment Trusts (REITS). See: Is it a Good Time to Buy REITS? for more information.

See Also: Doing the Roth Arithmetic

About the Author:

Christopher is a thoughtful writer who always comes up with something unique. He has a wonderful sense of writing and communicating his thoughts in an easy-going manner. He is associated with www.isarates.org.uk through which he keeps the readers updated and aware. He is a loving dad and caring husband who likes to cook for his family during vacations!

Form 1099B

In 2008, Congress under then President George Bush enacted changes to the Federal requirements for cost basis tax reporting that required stockbrokers to report this information to customers and the IRS. This legislation laid out the timelines for reporting the cost basis for various instruments and securities purchased by investors.

When filing your tax returns, you will now get a new Form 1099B issued by your stockbroker. Let us briefly look at the changes and how it will affect you. This new legislation is being phased in and is effective as of:

• Equity securities transactions effective January 2011
• Sale of Mutual funds and dividend reinvestment plans effective January 2012
• Trading in options and fixed income securities effective January 2013

3 Things to Note about Your 1099B

Tax form, Filing Taxes 1040 Form—Philip Taylor PT (Flickr.com)

While the impact of this legislation will be felt by all market intermediaries, for our purposes we will only look at its impact on investors. Since this is only effective 2011, you don’t need to worry about your tax returns for any period prior to January 2011.

1) The first thing you should do is examine your statements that you receive from your broker and ensure that the correct cost basis for the stocks that you hold is reflected. This is important especially when you bought the same stock(s) at different price levels.

2) When you sell your stocks, you need to specify the basis on which you want the cost to be calculated, i.e. match the stock sale to the preferred purchase amount. To minimize the impact of capital gains, you may want to specify the highest cost of acquisition as the lot that is sold first. Else, by default, your broker would use the First in First out (FIFO) method to report the cost of acquisition and arrive at the capital gains.

3) The third thing you need to keep in mind is when you change brokers. You should ensure that correct information is passed on to your new broker.

1099B Problem areas:

While the treatment of cost basis seems fairly straightforward for most stocks, there are some areas that require more attention.

For example, some brokers reported cost information pertaining to some Exchange Traded Funds (ETFs) while investors had to figure out the information for someother ETFs. You may need to fill out a new form called 8949 that will provide detailed information on tracking down the purchases and sales into lots and tell the IRS how the brokerage tracks the information.

Also, you need to reconcile any difference in your method of calculating the costs vis-à-vis what the broker reported. Brokers also factor in the effect of “wash rule sale” and hence may issue an amended 1099B to you if any of the capital loss that you would have claimed otherwise is disallowed. So, if you have filed your tax returns early, you may end up filing a revised one, if your broker issues you with a revised form.

It is possible that you may hear from the IRS if what you reported on your tax returns is not consistent with what your broker reported. You need to be aware of the changes and be prepared to respond if you face an audit.

Tax-Filing Headaches Stem From Stock Basis Reporting BusinessWeek

Author Bio:

Christopher is a finance professional, blogger and caring husband. He has contributed many posts on Elite Money saving tips and profitable investments. He is passionately working towards creating an exceptional portfolio of investment properties.

Investing Using Moving Averages

When investing in financial markets, there are many different indicators and systems that you can use to determine when to enter into a position, and just as importantly, when to exit a position. One of the most popular indicators that investors employ to help make intelligent decisions are moving averages. What exactly is a moving average and how can you use it to invest in the financial markets?

 What is a Moving Average?

Simply stated, a moving average is the average price of a stock over time.

To be a little more technical, a moving average is a statistical measurement (the mean) of a dynamic set of data (aka “rolling”) that helps to identify trends in the underlying instruments. A 13-week moving average provides the average price of the financial instrument using the stock prices for the preceding 13 weeks. A 50-week moving average uses data from the preceding 50 weeks, etc. Each new day, the oldest day’s data is removed from the population and the current day’s data is added; in this way the population is always equal to 13 weeks’ worth of data, measured from that day back.

The moving average is a linear measurement of the average price of a stock over the period in question. The line communicates the historic trend of a stock’s price. Most consumer trading platforms offer moving average indicator tools for use in technical analysis.

There are two different types of moving averages that you could use: simple and exponential.

 Simple vs. Exponential Moving Averages

Although both the simple and exponential moving averages provide you with the same type of information, the way that these averages are calculated differ. With a simple moving average, the average is calculated by taking the average price of the security and dividing it by the number of periods that you are using. For example, if you are computing a five-day simple moving average, you take the closing price of the security for the last five days, add them and divide by five.

The exponential moving average uses a calculation that puts more emphasis on the most recent price data. Recent changes in price are given greater weight than the more historic measurements, which reflects a greater weight on current news and data than applying equal weight to all periods. This calculation effectively expresses the view that data today is more important (or pertinent) than older data.

Moving averages are a lagging indicator

As with all lagging indicators, moving averages communicate the direction that an instruments price has moved historically. While the past may predict the future, it may not. A moving average could very well be trending upward and a stock’s price can move downward. A moving average will also “smooth out” volatile data. So if prices bounce around a lot the moving average will provide a much clearer picture of the actual trend. For instance on Financial Trend Forecaster’s NYSE ROC chart you can see whether the 12 month Moving average (red line) is slanting down or up or is basically flat.

Trading Strategy: How to Use Moving Averages

Moving averages are best used in conjunction with other indicators and are often most valuable when a stock is trending in one direction or another (as opposed to trading in a range). Following are some common uses of moving averages in this situation:

• A moving that average is trending upward, and the current stock price is above the moving average, may communicate a bullish signal.
• A bullish (buy) indicator may also arise if a stock crosses the moving average (i.e. moves from below to above it); in contrast, if a stock drops below a moving average (from above), this indicates a bearish (Sell) sentiment.

Often, moving averages from different periods are used in conjunction with one another. A short-term moving average may be used in concert with a long-term moving average. If the short-term average moves above the long-term average, this may send a bullish signal (and vice versa).

The periods used should mirror your trading horizon. If you are a long-term investor, you should use longer-term moving averages. You can still use a “short” and a “long” term moving average, the averages should just mirror your trading philosophy. In other words, if you plan to hold a position for years, use averages that span weeks or months. If you plan to hold a position for days, then use averages that span hours or days. Using the wrong moving average for your overarching trading strategy will  create confusing signals.

 Using Moving Averages With Other Indicators

Many of the other indicators that you may use on your trading platform are based on moving average concepts. For example, the MACD (moving average convergence divergence) is an indicator that uses a fast moving average and a slow moving average to identify when trends are forming. Bollinger bands and some of the other leading indicators also use some kind of moving average.

When you plan on trading the market, moving averages can be a valuable tool to use, but they are generally best used in conjunction with other indicators.

For more information see: Moving Averages: Determining the Trend and Avoiding the Whipsaws

Also : Elliott Wave International (EWI) has released a free 10-page trading eBook: How You Can Find High-Probability Trading Opportunities Using Moving Averages, by Senior Analyst Jeffrey Kennedy. Download Your Free eBook Here.

About the Author:

April Santos manages her own financial portfolio and actively uses moving averages as a basis for her technical research, particularly when making entry and exit decisions. She also works as a freelance writer for the team at www.generalinsuranceagency.com, who believe that everyone should work to develop their financial acumen.

The Manic-Depressive Stock Market: What to Make of It

The psychology of the market may be teetering on the edge

The stock market: one week it acts like Dr. Jekyll, the next week it’s Mr. Hyde.

That shift can even occur in the course of a single session.

These dramatic fluctuations appear to be impulsive; and we know that impulse does not flow from cold reason. Even so, the Efficient Market Hypothesis would have us believe that investors are constantly applying reason and logic to reach some objective market pricing, via the latest news or measure of stock market valuation.

The February 2010 Elliott Wave Theorist provides insight:

The Efficient Market Hypothesis (EMH) and its variants in academic financial modeling…rely at least implicitly but usually quite explicitly upon the bedrock ideas of exogenous cause and rational reaction. Stunningly, as far as I can determine, no evidence supports these premises…

EMH argues that as new information enters the marketplace, investors revalue stocks accordingly. If this were true, then the stock market averages would look something like the illustration shown [below].

We know that the market does not unfold in the way illustrated above. But we do know that the market has unfolded like this:

So in 2000, did a sudden burst of logic lead investors to realize that the NASDAQ was over-valued?

No. Technology stocks had absurd price/earnings ratios long before the NASDAQ top.

The NASDAQ’s abrupt switch from Hyde to Jekyll stemmed from investors’ collective unconscious. Consider the gazelle that runs in panic because others are: it does not pause to rationally survey the landscape. It explodes in a burst of speed that reaches 90 km/hr within seconds.

Decades ago, multimillionaire stock market operator Bernard Baruch said

…the stock market is people. It is people trying to read the future. And it is this intensely human quality that makes the stock market so dramatic an arena, in which men and women pit their conflicting judgments, their hopes and fears, strengths and weaknesses, greeds and ideals.

This psychology of the marketplace unfolds in waves. That is what we study.

Want to learn what REALLY drives the markets?The FREE 50-page Independent Investor eBook will challenge conventional notions about investing and explain market behaviors that most people consider “inexplicable.”You’ll learn how extreme market psychology affects the markets, with some eye-opening charts that provide shocking evidence of the real forces at play in the markets.We promise to show you a whole new way of thinking about investing. Download the FREE 50-Page Independent Investor eBook Now >>

Stock Market Turning Points: Has Wall Street Ever Warned You in Time?

Divorce yourself from the crowd. Independence is good.

In the play “The Secret to Freedom,” Pulitzer prize writer Archibald MacLeish had a character say this:

The only thing about a man that is a man is his mind. Everything else you can find in a pig or a horse.

MacLeish knew how to state the truth plainly.

And the truth is, you can use your mind in any way you wish.

When it comes to financial markets, most allow others to do their thinking for them. You’ve heard the phrase “the blind following the blind.” Yes, they both fall into the ditch.

At Elliott Wave International, our mission is to keep our subscribers out of the ditch. To do so, we must first do our own financial thinking before offering our conclusions to subscribers.

Robert Prechter found it easier to think independently by being physically removed from Wall Street. In this excerpt from the book Prechter’s Perspective, Prechter was responding to an interviewer who asked about Prechter living 60 miles north of Atlanta:

It’s an advantage in my opinion to be away from the storm of mass psychology that exists in the financial centers. I have purposely distanced myself from New York to avoid the overload of superfluous information that you are exposed to there. I am an observer of crowd behavior. I think it is extremely difficult to shield yourself from the crowd’s influence when you are part of it.

Now, we don’t advocate contrarianism for its own sake. That would be just as big a mistake as letting the Wall Street crowd do your thinking for you.

That said, our financial analysis is born of deliberate independence.

Granted, the crowd might be right for a time, but generally not for long, and never at important turning points.

Learn to Think Independently Being an independent investor never goes out of style — whether the markets are bullish or bearish. Learn to challenge conventional notions about investing and explain market behaviors that most people consider “inexplicable” with the FREE 50-page Independent Investor eBook. You’ll get some of the most groundbreaking and eye-opening reports ever published in Elliott Wave International’s 30-year history; you’ll also get analysis, forecasts and commentary to help you think independently in today’s tumultuous market. Download the free 50-page Independent Investor eBook now >>

Is an Economic Implosion Imminent?

In the following article from Elliott Wave International, statistical data shows it is coming and what you need to do to be prepared ~editor

How to Handle an Economic Implosion

I came across some research on the subject of worry. Here’s how it was presented:

Things People Worry About:

• things that never happen – 40%
• things which did happen that worrying can’t undo – 30%
• needless health worries – 12%
• petty, miscellaneous worries – 10%
• real, legitimate worries – 8%

Of the legitimate worries, half are problems beyond our personal ability to solve. That leaves 4% in the realm of worries people can do something about.

I thought about our gigantic national debt and weak economy. These seem to fit into both subcategories of “real” worries. You can’t do much as an individual to solve the nation’s debt and economic problems, yet you can prepare for a worsening economic downtrend.

Do we see evidence for an economic turn for the worse?

Well, consider that the evidence is so overwhelming that it took 456 pages of the second edition of Robert Prechter’s book, Conquer the Crash, to cover it. And since that book published, Prechter has consistently devoted his monthly Elliott Wave Theorist to the facts and evidence behind his forecast.

Here’s a chart from the book that was updated by Elliott Wave International in March 2012:

The downturn from 2008 is critically important, as it shows that after an almost unbroken 60-year climb, the contraction is underway. It surely has much further to go, because it is still a third higher than it was at the outset of the last debt deflation in 1929.

– The Elliott Wave Financial Forecast, March 2012

The rating agencies are well aware of what the above chart means. You probably know that Standard & Poor’s downgraded U.S. debt from the nation’s long-standing triple-A to AA+. Now, another rating agency has taken their rating even lower:

Rating firm Egan-Jones cuts its credit rating on the U.S. government to “AA” from “AA+” with a negative watch, citing a lack of progress in cutting the mounting federal debt.

– CNBC.com, April 5

Robert Prechter’s bestseller, Conquer the Crash, provides practical information about what you can do to protect your finances in the coming economic implosion. And right now, Elliott Wave International is offering 8 lessons from Conquer the Crash in a free 42-page report that covers:

• What to do with your pension plan
• How to identify a safe haven
• What you should do if you run a business
• A Short List of Imperative “Dos” and Don’ts”
• And more

In every disaster, only a very few people prepare themselves beforehand. Discover the ways you can be financially prepared and safe.

Get Your FREE 8-Lesson “Conquer the Crash Collection” Now >>

Today we sit down with Elliott Wave International’s Futures Junctures Editor and Senior Tutorial Instructor Jeffrey Kennedy to discuss his favorite wave pattern of all: the diagonal.

EWI: You say if you had to pick just ONE of all 13 known Elliott wave structures to spend the rest of your technical trading life with, it would be the diagonal. First, tell us what the diagonal is.

Jeffrey Kennedy: The diagonal is a five-wave pattern labeled 1 through 5, in which each leg subdivides into three smaller waves: 3-3-3-3-3. Unlike impulse waves, however, diagonals are the only five-wave structures in the direction of the main trend in which wave 4 almost always moves into the price territory of wave 1. (See illustrations below.)

EWI: So, what makes this pattern so darn special?

JK: As you can see in the above charts, the diagonal is a terminating pattern. They can only occur in waves 5 of impulses or C-waves of corrections. This is why they’re so exciting. Diagonals precede a dramatic change in trend. And, when they end, prices tend to retrace the entire pattern, or more, and fast — in 1/3 to 1/2 the time it took the pattern to form.

Put simply: If you see a diagonal, you know the train of change is coming into the station.

EWI: Well, in your Daily Futures Junctures service, you do, in fact, see a diagonal underway in the recent price action of a major grain market. There, you present the following Elliott wave chart (some Elliott labels have been removed, while I took the liberty to draw a blue circle around the diagonal pattern for clarity):

JK: Yes. This is a classic diagonal unfolding in the final wave of the larger trend. As you can see, prices have put the finishing touches on wave (v) of c (circled). And, if my wave count is correct, this market’s prices are about to board the “Exciting Southbound Turn” Railway.

EWI: Thank you so much for taking the time to explain the ins and outs of your favorite structure, the diagonal. And also, for alerting readers to the possible DRAMA in store for this major grain market thanks to this Elliott wave pattern.

Learn More about Diagonals and Other Elliott Wave Patterns Get a better understanding of Elliott wave analysis with our Elliott Wave Patterns educational feature. You’ll have access to basic lessons on Elliott wave patterns, along with video clips from our online courses which will explain the pattern, the rules and the guidelines. Plus, you’ll see real-life examples that show you how each pattern fits into the overall wave structure. Some patterns will even offer a brief quiz to test your knowledge and ensure that you understand the material. Access the free Elliott Wave Patterns feature now.

Learn Jeffrey Kennedy’s tips for becoming a consistently successful trader

You’ve probably heard talk about “market uncertainty” in the financial news recently. But when are the market trends ever certain? The constant uncertainties contribute to your frustrations as a trader, and you need to have a method for dealing with the ups and downs. Every successful trader has one.

Since 1999, Elliott Wave International’s senior analyst and trading instructor Jeffrey Kennedy has produced hundreds of trading lessons exclusively for his subscribers. One of these lessons, “The Three Phases of a Trader’s Education,” gives you Jeffrey’s tips on becoming a consistently successful trader.

Here it is; we hope you’ll find it helpful.

The Three Phases of a Trader’s Education:
Psychology, Money Management, Method

Aspiring traders typically go through three phases in this order:

1. Methodology – The first phase is that all-too-familiar quest for the Holy Grail — a trading system that never fails. After spending thousands of dollars on books, seminars and trading systems, the aspiring trader eventually realizes that no such system exists.
2. Money Management – So, after getting frustrated with wasting time and money, the up-and-coming trader begins to understand the need for money management, risking only a small percentage of a portfolio on a given trade versus too large a bet.
3. Psychology – The third phase is realizing how important psychology is — not only personal psychology but also the psychology of crowds.

But it would be better to go through these phases in the opposite direction. I actually read of this idea in a magazine a few months ago but, for the life of me, can’t find the article. Even so, with a measly 15 years of experience under my belt and an expensive Ph.D. from S.H.K. University (i.e., School of Hard Knocks), I wholeheartedly agree. Aspiring traders should begin their journey at phase three and work backward.

I believe the first step in becoming a consistently successful trader is to understand how psychology plays out in your own make-up and in the way the crowd reacts to changes in the markets. The reason for this is that a trader must realize that once he or she makes a trade, logic no longer applies. This is because the emotions of fear and greed take precedence — fear of losing money and greed for more money.

Once the aspiring trader understands this psychology, it’s easier to understand why it’s important to have a defined investment methodology and, more importantly, the discipline to follow it. New traders must realize that once they join a crowd, they lose their individuality. Worse yet, crowd psychology impairs their judgment, because crowds are wrong more often than not, typically selling at market bottoms and buying at market tops.

Moving onto phase two, after the aspiring trader understands a bit of psychology, he or she can focus on money management. Money management is an important subject and deserves much more than just a few sentences. Even so, there are two issues that I believe are critical to grasp: (1) risk in terms of individual trades and (2) risk as a percentage of account size.

When sizing up a trading opportunity, the rule-of-thumb I go by is 3:1. That is, if my risk on a given trading opportunity is $500, then the profit objective for that trade should equal $1,500, or more. With regard to risk as a percentage of account size, I’m more than comfortable utilizing the same guidelines that many professional money managers use — 1%-3% of the account per position. If your trading account is $100,000, then you should risk no more than $3,000 on a single position. Following this guideline not only helps to contain losses if one’s trade decision is incorrect, but it also insures longevity. It’s one thing to have a winning quarter; the real trick is to have a winning quarter next year and the year after.

When aspiring traders grasp the importance of psychology and money management, they should then move to phase three — determining their methodology, a defined and unwavering way of examining price action. I principally use the Wave Principle as my methodology. However, wave analysis certainly isn’t the only way to view price action. One can choose candlestick charts, Dow Theory, cycles, etc. My best advice in this realm is that whatever you choose to use, it should be simple. In fact, it should be simple enough to put on the back of a business card, because, like an appliance, the fewer parts it has, the less likely it is to break down.

14 Critical Lessons Every Trader Should Know Read more of Jeffrey Kennedy’s lessons in his 45-page eBook, The Best of Trader’s Classroom. Find out why traders fail and how to make yourself a better trader with lessons on the Wave Principle, bar patterns, Fibonacci sequences, and more when you download your FREE eBook today! Don’t miss your chance to improve your trading. Download your free eBook here.

Jeffrey Kennedy has developed a theory that guides his analysis

When you are watching a pattern develop on a chart, how can you be sure that your wave count is correct? The Elliott Wave Principle offers rules and guidelines that you can use to add confidence to your wave count.

Elliott Wave International’s Senior Analyst Jeffrey Kennedy spent years designing his own technique to improve his accuracy. He came up with the Jeffrey Kennedy Channeling Technique, which he uses to confirm his wave counts. The following excerpt from Jeffrey’s Trader’s Classroom lessons, a regular feature of his Futures Junctures Service, offers an overview of his method.

My theory is simple: Five waves break down into three channels, and three waves need only one. The price movement in and out of these channels confirms each Elliott wave.

Base Channel
Figure 61 shows three separate five-wave patterns with three different channels drawn: the base channel, the acceleration channel and the deceleration channel.

The base channel contains the origin of wave one, the end of wave two and the extreme of wave one (Figure 61A). Of the three channels, the base channel is most important, because it defines the trend. As long as prices stay within the base channel, we can safely consider the price action corrective. Over the years, I’ve discovered that most corrective wave patterns stay within one price channel (Figure 62). Only after prices have moved through the upper or lower boundary lines of this channel is an impulsive wave count suitable, which brings us to the acceleration channel.

Acceleration Channel
The acceleration channel encompasses wave three. Use the extreme of wave one, the most recent high and the bottom of wave two to draw this channel (Figure 61B). As wave three develops, you’ll need to redraw the acceleration channel to accommodate new highs.

Once prices break through the lower boundary line of the acceleration channel, we have confirmation that wave three is over and that wave four is unfolding. I have noticed that wave four will often end near the upper boundary line of the base channel or moderately within the parallel lines. If prices break through the lower boundary line of the base channel decisively, it means the trend is down, and you need to draw new channels.

Deceleration Channel
The deceleration channel contains wave four (Figure 61C). To draw the deceleration channel, simply connect the extremes of wave three and wave B with a trend line. Take a parallel of this line, and place it on the extreme of wave A. As I mentioned before, price action that stays within one price channel is often corrective. When prices break through the upper boundary line of this channel, you can expect a fifth-wave rally next.

In a nutshell, prices need to break out of the base channel to confirm the trend. Movement out of the acceleration channel confirms that wave four is in force, and penetration of the deceleration channel lines signals that wave five is under way.

14 Critical Lessons Every Trader Should Know Since 1999, Jeffrey Kennedy has produced dozens of Trader’s Classroom lessons exclusively for his subscribers. Now you can get “the best of the best” in these 14 lessons that offer the most critical information every trader should know. Find out why traders fail, the three phases of a trader’s education, and how to make yourself a better trader with lessons on the Wave Principle, bar patterns, Fibonacci sequences, and more! Don’t miss your chance to improve your trading. Download your FREE 45-page eBook today!