Saturday, May 30, 2009

An Elliot Wave Trade In MCO

When MCO went public in 2000 I was still in my trading infancy. In retrospect, it would have been a great long trade, almost a 10 bagger. I had a hard time believing in MCO because of its business model, which is clearly based on a conflict of interest, which clearly contributed to the current economic crisis. That said, once it had completed 5 waves of cycle degree in 2007, I did complete two successful short trades in cycle wave A down. After the completion of cycle wave A, I waited for some time to see how the pattern would unfold.
As it turned out, MCO traced out two back to back flats creating an expanding wedge pattern sometimes called a megaphone, which appeared to be bearish in and of itself. It was then fairly easy to see that cycle wave B completed as an upward flat correction, which was followed by intermediate wave (1) of C down in 5 waves, followed by another flat correction in wave (2) up.
On 9/9/08, MCO completed wave ii of (3) of C down forming a perfect fractal pivot. I entered an order to go short at 37.90 STOP LIMIT, which was filled two days later on 9/11/08. Remember at that time, the broader markets were already in a confirmed downtrend after the August 08 top. My initial stop was 43.10. I did not do anything else as far as managing the trade. On 9/19/08 the markets rallied sharply and IBD called the market in a confirmed uptrend. Even though MCO also rallied in a smaller degree second wave, it closed badly that day and there was no reason to exit the trade. By the end of the month MCO had made a new low and I lowered my stop to 40.00, just above the 9/19/08 high. I continued to lower my stop with each new swing low.
Since cycle wave A completed in 5 waves, it was a high probability that cycle wave C would also complete in 5 waves. So, all there was to do at that point was count. You can see on the detailed daily chart above that no swing high was violated until wave v of (3) was finished on 11/20/08. I had calculated and posted a potential market turning point on this site of 11/26. Although a little early, wave (3) was definitely complete, so I exited one-half of the position around 16.60 on 11/21.
I projected a potential low in MCO around 12.00 based on fib extensions and the potential length of wave (5) in relation to waves (1) and (3), which was reason enough to hold onto the second half until wave (5) was complete. Wave (4) completed as a simple double zigzag, but it made a higher high as the broader markets were falling in February, a sign of relative strength. From there wave (5) fell in 5 waves to a low of 15.57 on 3/6/09. Sensing that the broader markets were due for a sharp countertrend rally due to the overall negative sentiment, I exited the second half of the trade that day as it rallied into the close at 15.92. At that point, it was still possible that only wave i of (5) was completing, but the risk was balanced. When the outcome is a coin toss, I prefer to take profits.
Overall, the gain on the trade was 57.10%.
For me the big take-away from this trade was not that I nailed both the entry and the exits, which I did. (This was a huge confidence booster for me and one of my best elliot wave trades.) Rather, it is the fact that I literally followed the big picture on this stock for 8 years. This gave me a powerful intuitive feel for its behavior as well as strong confidence in my analysis.
When traders get caught up in indicators and abstract buy and sell signals, they can lose sight of the big picture. Sometimes, it can take months and years of observation before you see a really great trade develop. Those months and years will give you the confidence to pull the trigger when the target is in sight, if you don't feel compelled to take every signal. Watch the market, analyze it, develop a trading plan, be patient and wait for the trade to come to you.
As for the current market action, now is a time to be patient and wait for a new entry.
(Note: there is a problem with the paragraph style in blogger. Hopefully, it will be fixed soon.)

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