Improving Wolfe Waves with Median Lines

Before I get into the details, let me first outline the problem. The issue with Wolfe Waves is that due to the use of trendlines, it can be complicated to identify the price points. Both in terms of trade entry, profit levels and stop losses. Usually, the sweet zone is often considered a good entry point with the EPA line as the target level. But the problem is that in order to wait for a definite confirmation, in most cases, either the trade is entered or exited a bit too early or too late. Where exactly on the EPA line can one book profits?

In case of an ideal wolfe wave where ETA and EPA is respected, the price targets are easy to identify, but that is not the case in real time trading, which brought me to using Median Lines alongside Wolfe Waves.

One might argue that using Median lines might be redundant. Sure... but let's explore this in detail.

Wolfe Waves are nothing but a pattern that is used to identify price reversals. Median lines do the same thing as well, where in the failure to reach the median line often results in a change in trend (could be either consolidation or indeed a trend reversal). Again, with Median lines, there is no definite price points to enter and exit trades.

So why use Median lines?

I feel that Median lines might give us the answer, or rather the first indication of a price failure (read as reversal). Thus, Median lines could potentially point us towards an early trend change and thus alert us for taking up a position.

So let's look at some examples. In this article, i'll introduce this concept in hindsight for Facebook stock and in upcoming articles, i'll touch upon this concept in real time as the Wolfe Wave is formed.

The first example is that of the Facebook stock on the daily charts.

Facebook, Daily Chart - Wolfe Waves

We have plotted a bullish Wolfe Wave. So, if we were to go long, what would our price point be? After price breaches the 1-3 TL, we have a very large price range from $26.19 through $22.99. Even though the TL2 -4 parallel line acts as a guide for us, there is still no clear region for entry. Furthermore, it is not always that price touches this parallel line and reversal could happen well within the sweet zone. During such times, waiting for a confirmation could result in a late entry while entering a trade too early could lead to whipsaws.

Let's now introduce Median lines into this existing Wolfe Waves to see if it is of any help.

Because we're looking at a bullish Wolfe Wave, we'll start our Median Line from Point 2 which forms the high, 3 which forms the low and 4 which forms the next peak. We get a downward sloping Median line which is in line with the bullish price move.

Facebook, Daily Chart - Wolfe Waves with Median Lines. Entry/Stops

Using Median Lines for Stops and Trade Entry

Firstly, we need to lookout for the lower Median line. A breach of the lower median line would give us an indication of a failure of the Wolfe Wave as a whole. In terms of improving our trade entry, we'll let the Median line indicate to us about a price reversal, which generally happens near the median line.

Putting this together, we now see that price breached the Wolfe Wave TL2-4 Parallel line, which by itself would have not indicated anything to us. By using Median lines, we are now aware that price was dangerously close to breaching the lower median line but stopped short and reversed to the Median line.

Because price moved back above the TL2-4 parallel line, we would be looking to enter at a new candle open above the median line, which would be at $24.11 with stops a few pips below the previous key low at $22.68. From this stops, it is clear that if stops were to be hit, it would indicate a further downtrend in the stock price.

Using Median Lines for Target Levels

Facebook, Daily Chart - Wolfe Waves with Median Lines.Price Targets

Staying with the same Median lines, we can then identify our first obvious price target as Point 2 Wolfe Wave, which is $32.51. So this long trade on Facebook would have been:

Entry @ $24.11
Stops @ $22.68
Target 1 @ $32.51

Thus giving us a risk/reward ratio of almost 1:6.

We could improve upon this by plotting another median line that would project this into the future along with the ETA line. A confluence of these two lines would be our next price target, which is $35, improving our risk/reward to 7.5

While this forms just our first example, its easy to see how Median Lines can prove to be a valuable addition to increasing the odds of improving trading with Wolfe Waves. I will cover more such examples in upcoming articles and hopefully catch a few failed trades as well which will give us more hints on improving this method.

I welcome all comments and thoughts on this approach.