The Wolfe Wave Forex Trading Strategy

Introduction to the Wolfe Wave Trading

Wolfe waves were discovered by Bill Wolfe, an S&P500 index trader. He described the strategy that will be described below, and created the indicator which goes by the same name, used in trading this strategy. The Wolfe waves work a bit like the Elliot waves, albeit there are some differences in both systems.

Market moves in a trend do not occur in a straight line. The movements are wavy in nature with alternating moments when price action dips or peaks in response to the dynamics of supply and demand that play out on each currency pair in the forex market.

What Wolfe Waves do is to get the 1-2-3-4-5 wave formations seen with Elliot waves, and put them into a shape context which can be traded as bullish or bearish.

Below, we see the basic Wolfe wave structure for bull and bear markets.

Wolfe_bear2

 Bearish Wolfe Wave

Wolfe_bull

Bullish Wolfe Wave

The Wolfe Wave formations are therefore used to define the market trend with all the price retracements and continuations, as well as areas where the price action forms support and resistance areas. The trader can also detect the Expected Time of Arrival of the final wave as well as the Expected Point of Arrival (which is used as the Take Profit for the trade from the commencement point of wave 5.

Indicator

This strategy relies on visual identification of the 1-2-3-4-5 Wolfe wave formation on the 1hr, 4hr and daily time frame. However, there are now commercial versions of the Wolfe-wave indicator. Be sure to request for a free test to see if the indicator actually identifies the formation and does not repaint. A few indicators I have tested did not meet required standards: wrong traces and repaints were the order of the day. So ensure you master the visual recognition of the Wolfe wave before going on to buy one of the indicators out there.

The Strategy

The Wolfe wave consists of a 1-2-3-4-5 wave formation, with 2 and 4 being the retracement waves seen in the Wolfe Wave formation. You can see the sequence from the snapshots above.

  1. Point 2 is the highest and lowest part of a bullish or bearish Wolfe wave respectively.
  2. Point 1: is the starting point of the wave.
  3. Point 3 is the bottom formed by a price retracement (up or down) from point 2.
  4. Point 4 is at a lower horizontal level than point 2, is the top of the 3-4 wave sequence and the topmost part of the price rally from point 3 (bullish wave). However in a bearish wave, it is the bottom of a 3-4 wave sequence, at a higher horizontal plane than point 2.
  5. Point 5 is the trade entry point, and is expected to hit the EPA (the take profit point) by meeting a line drawn from point 1 which also intersects point 4 (see snapshots above).
  6. The EPA (expected price at arrival) and the ETA (the expected time of arrival of price action from point 1 to 3 to 5) must be on the same vertical plane.

Perform the trace as shown in the snapshots. The lower trend line must connect points 1 and 3 while the upper trend line must points 3 and 4. The completed traces will look like wedges.

Then see if you can trace a line from point 1 to the EPA. This should intersect point 4 on its way.

Note that at this stage, point 5, the EPA and ETA are unknown. So the line drawn from point 1 to intersect point 4 is drawn as long as possible into the future, while the line joining points 1 and 3 are also drawn into the future. The line joining points 2 and 4 is also drawn into the future to meet the line connecting points 1 and 3. Where these two lines join is the ETA, which should be on the same horizontal plane with the EPA.

The next step is to wait for where price will retrace from point 4 to the opposing trend line (point 5). This is the trade entry point.

1) Long Trade

Once price retraces downwards from point 4 to the trend line which connects points 1 and 3, enter a long trade at the open of the next candle. The snapshot below displays this:

wolfe_long

Stop Loss

The stop loss is placed a few pips below the new 1-3-5 trend line.

Take Profit

The Take Profit point is set to the EPA, which is the end point of a line drawn from point 1-4 and continued into the future, looking for a vertical alignment with the ETA which is the point where lines 1-3-5 and lines 2-4 meet.

2) Short Trade

Once price retraces upwards from point 4 to the trend line which connects points 1 and 3, enter a short trade at the open of the next candle. The snapshot below displays this:

Wolfe_short

Stop Loss

The stop loss is placed a few pips below the new 1-3-5 trend line.

Take Profit

The Take Profit point is set to the EPA, which is the end point of a line drawn from point 1-4 and continued into the future, looking for a vertical alignment with the ETA which is the point where lines 1-3-5 and lines 2-4 meet.

Conclusion

Once the initial trace of the Wolfe wave is perfectly done, there is no way this trade will end up in a loss. Follow the sequence of tracing and the entry/exit rules, and you will walk away with some good pips using this strategy.

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