Veteran forex trader Raghee Horner developed "The Wave" to determine what state the market was in - trending or non-trending, confused or bored. The wave is composed of three exponential moving averages (EMA) which move more strongly with recent price action than other moving averages.
In other words, the EMA takes more account of recent prices than historical ones. The 3 EMAs used are the 34 period EMA of high prices, low prices and close prices. The choice of the 34 period is based on the Fibonacci series.
An uptrend is determined as the angle of the 34 EMA wave being at a 12 - 2 o'clock angle. A downtrend is 4 - 6 o'clock angle and no trend is a 3 o' clock angle i.e. flat. Trading entry in a downtrend occurs when the market rallies back to the Wave low (the bottom line of the Wave). In an uptrend, a long position is taken when the market retraces back to the Wave high (the upper line of the Wave) see images below. This is essentially a pullback strategy.
Raghee has written a number of books, the most cited being "The Million Dollar Setup" which is available in our library of trading books. In essence, you want to buy closes above the 34 period EMA high in an uptrend and sell the 34 EMA average close in a downtrend. Criticism of her strategies is that they are not specific and rely heavily on trader discretion which isn't helpful if you're a new trader with little experience.
The Sonic R System
However, in 2008, a young man who calls himself the Sonicdeejay turned up on trading forums to publish his Sonic R System. At the heart of his trading system was Raghee Horner's Wave which he renamed the Dragon. Sonicdeejay developed a swing strategy on the 15 minute timeframe which requires Price, Volume, Support & Resistance Analysis or PVSRA. He identified two trading setups - the Classic and the Scout.
The Classic Setup
Simply, the Classic trading setup can be stated as: “Buy the first pull back from new high, sell the first pullback from new low”. The diagram below illustrates an example of classic setup.
But what about PVSRA? First you need to draw the Dragon being a 34 period EMA applied to the high, low and close prices. Add a 89 period EMA to determine trend - an upward cross of the 89 EMA by the Dragon indicates an uptrend and vice versa. Next you want higher volume to support your trade entry. Lastly add support and resistance levels to determine trend reversal points.
Your chart will look like this:
The Scout Setup
The Scout is a counter trend setup and is more risky than the Classic setup. The author of the system believes that a Scout setup during a Classic setup is the safest application. The Scout is essentially a re-entry of the Classic on a retracement or pull back. There are many strategies that are based on entry after a pullback to a moving average but these strategies rely heavily on trader discretion. An example of a Scout is this:
If you'd like to find out more about the Sonic R System, search the forexfactory.com website where there is a ton of information from the author.
The Sonic R Dragon
The Wave or the Dragon is a useful tool to determine trend because its construction takes account of recent price volatility. When volatility is high, the Dragon is wider and aims to prevent false signals. Using the cross of the 89 EMA (also a Fibonacci number) by the 34 EMA to determine trend is a precise rule that can be coded and indicators created.
Fibonacci Sequence
Other technical analysts have developed indicators where the defaults are Fibonacci numbers e.g. the Awesome Oscillator developed by Bill Williams Phd in the 1990's is based on the difference between the 5 period simple moving average (SMA) and the 34 period SMA. The first few numbers in the Fibonacci sequence are 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 …. The Golden Ratio is constant between adjacent numbers e.g. 55/34 = 1.618, 89/55 = 1.618.
The golden ratio found in this sequence occurs over and over in nature. Almost everything runs according to the Fibonacci ratios which imbues these numbers with "magical" properties. This natural mathematics is mimicked by traders in the markets. In technical analysis, Fibonacci Golden ratios and numbers are often used to determine trading periods, possible targets or levels of support/resistance. I think the connection between nature and man made financial makets is tenuous but you can decide for yourself.
Closing thoughts on the Sonic R Dragon
Using an EMA to measure or assess trend is better than its lagging cousin the SMA because greater weight given to recent data so the EMA responds more quickly to recent price changes than the SMA. This makes sense in that markets are not constant - they change in direction and volatility. The Wave or the Dragon attempts to account for volatility to keep the trader away from false signals when determining trend.
Personally, I find it hard to believe that the forces in nature that gave rise to the Fibonacci sequence have somehow permeated the servers and terminals of the world's stock exchanges to give traders an edge.
Perhaps there's an alternate explanation for the success of the 34 period moving average because its approximately the mid-point of a quarter. There are roughly 60 trading days in a quarter (5 trading days a week) at the end of which Institutional portfolios are reviewed & rebalanced. A 34 period moving average would therefore have sufficient price sensitivity to respond to massive Institutional flows during rebalancing. But whether the best number is 33 or 35 for the EMA period is immaterial because the Dragon is a guide not a strict rule. Like all other indicators, it should not be used in isolation but together with other indicators to confirm price action.
Useful Stuff
Download the Sonic Dragon indicator HERE
Download the Raghee Horner Wave HERE
Download "The Million Dollar Setup" by Raghee Horner HERE
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