Elliot Waves Theory and Fibonacci
The Elliott Waves theory is simply not possible without Fibonacci tools, and I am talking about the retracement and expansion ones. This is how important the Fibonacci is to counting waves with Elliott.
Fibonacci retracement tool is used at each and every moment, both when trading corrective or impulsive move, on all types of retracement. Below are just some examples:
- when looking for the 2nd wave to retrace between the 50%-61.8% level when compared with the 1st wave, the trader should take the retracement tool, measured the length of the first wave, and if the first wave is a bullish one, or a move to the upside, than a BUY order / CALL option can be placed when price reaches that area; the opposite is true with SELL orders.
- when looking for the b wave in a corrective structure is important to look at the 61.8% level as this one is making the difference between flats and zigzags;
- also in trading triangles, it is well known that three out of five legs of a triangle need to retrace more than 50% so that level can be found using Fibonacci retracement tool too.
Using the Expansion Tool
The above are only some situations in which Fibonacci retracement tool can be used when trading forex, and the recordings that are coming with this educational series cover the other Fibonacci tool as well: the expansion one. Like mentioned at the beginning of this article, Fibonacci numbers are everywhere around us and it was simply not possible not to be related to the technical analysis of financial markets.
Fibonacci tools are being offered by every trading platform and they vary from Retracement and Expansion tools, all the way to Time and Arcs. In all situations, indicators can be edited and levels added as, depending on the trading theory one is using, different Fibonacci retracement or expansion levels can be used.
Regarding the Elliott Waves Theory, the Fibonacci levels should be divided between levels that are used with impulsive and corrective moves. This is important as impulsive moves have specific conditions, while corrective waves have clear limitations. In an impulsive move, the second wave cannot retrace more than the start of the first wave. To be more specific, no parts of the second wave should retrace below the beginning of the first wave and this makes the 100% retracement level impossible.
However, in corrective waves this is possible as the b wave in a flat, for example, can retrace more than 100% when compared with the length of previous wave a and in this case it is being said that market is forming a flat with a strong b wave. The way to see if the retracement is bigger, is to drag a Fibonacci expansion tool.
Corrections with Large X Wave
The same level can be used in corrections with large x waves as these corrections always travel more than 61.8% when compared with the previous correction and most of the times the whole previous correction is 100% completely retraced.
Coming back to impulsive moves, in order to find out the extended 3rd wave, if it is the third wave that is extended, then again Fibonacci Extension tool should be used by clicking and dragging the tool from the beginning of the first wave all the way to the end of the second one and the outcome represents the length of the third wave. Keep in mind that 161.8% is only the minimum requirement for the third wave in our case to be extended as very often, in strong impulsive moves, market is travelling way beyond that level, reaching levels like 261.8% or even more.
Moving forward, it is very rare that the fourth wave is retracing more than 38.2% when compared with the length of the previous third wave and this means that by the time the 23.6% level is reached we should look into buying underlying assets in a bullish impulsive move and selling in a bearish impulsive move. Not to mention that the same argument is valid if price is reaching the 50% level and the option that is traded here should be more aggressive than the previous ones.
Trading the Fifth Wave
The fifth wave in any impulsive move is tricky one as it is strongly dependent on the type of the extension we had so far as by now we should know which wave is the longest one. If we have a third wave extension, then looking for the rule of equality between the first and the fifth waves will do the trick and will offer plenty of information for future trading opportunities. On the other hand, a first wave extension should be followed by traders looking to buy put options on any move after the fourth wave is completed.
All in all, Fibonacci and Elliott go hand in hand and while in FX trading Fibonacci is giving the stop loss and take profit, it also is offers finding the entry/strike price.