Fibonacci and Elliott waves are two technical analysis tools used by many traders. Their combination creates synergy to help predict market trends. Join Forex Trading to discover what Elliott Wave and Fibonacci Retracement are and how to apply them in technical analysis.
Overview of the Fibonacci and Elliott waves concept
Before going into details, you need to have an overview of Elliott and Fibonacci waves. Have you heard the term Elliott wave but still understand its nature and applications? Find out below.
What are Elliott waves? Structure of Elliott wave
Elliott Wave is a technical analysis theory on the Forex and stock markets. It was developed by Ralph Nelson Elliott based on the hypothesis that prices in the market move in a wave pattern over a certain period.
The structure of Elliott waves is divided into two main types of waves: impulse waves and correction waves. There are 5 impulse waves (following the main trend) and 3 correction waves (moving against the main trend). Impulse waves are numbered from 1 to 5, in which waves 1, 3, and 5 are bullish waves in an uptrend (or bearish in a downtrend), and waves 2 and 4 are opposite corrective waves. The 3 corrective waves, denoted A, B, and C, move opposite to the main trend. Wave B usually has a zigzag shape, more complex than waves A and C.
Elliott wave rule:
- Wave 2 cannot decrease more than 100% of wave 1.
- Wave 4 cannot coincide with or duplicate wave 1.
- Wave 3 tends to be the strongest in the series.
Mastering the structure and principles of Elliott waves helps determine the current position of the market. This helps traders make appropriate trading decisions.
See more: Elliott wave principle help you trade Forex successful
What is Fibonacci retracement?
Fibonacci retracement is a technical analysis tool based on the famous Fibonacci number sequence. This number sequence starts with 0 and 1, the next numbers are the sum of the previous two numbers (0, 1, 1, 2, 3, 5, 8…).
Fibonacci retracements use percentages calculated from the Fibonacci number sequence. This helps identify potential support and resistance levels on the price chart. Common levels include 23.6%, 38.2%, 50%, 61.8% and 78.6%.
When price moves in a trend, it often tends to “retrace” or correct to Fibonacci levels before resuming the main trend. Traders use Fibonacci retracement levels to identify potential entry points or place stop-loss orders.
How to trade Fibonacci and Elliott waves
Elliott and Fibonacci wave analysis helps traders identify potential support/resistance areas. Besides, it helps traders determine effective profit goals. Let’s find out below
Use Fibonacci to identify support/resistance zones in Elliott waves
Fibonacci retracement levels are used to identify potential support/resistance areas within the Elliott wave structure. For example, in an impulse wave, the 61.8% Fibonacci level of the previous wave can act as support for the current wave. Similarly, in a correction, the 38.2% or 61.8% Fibonacci level of the previous impulse wave can act as a resistance zone.
Fibonacci Retracement levels are often used to predict the end of a corrective wave and the start of the next trend wave. From there, you can identify target price zones and make appropriate trading decisions
Use Fibonacci to determine profit targets in Elliott waves
Fibonacci extension levels help predict potential profit targets in Elliott waves. Common levels are 161.8%, 261.8%, and 423.6%.
In an impulse wave, the Fibonacci extension level of the previous wave can determine the target for the current wave. For example, the profit target for wave 3 can be predicted by taking the 161.8% Fibonacci level of wave 1.
Similarly, in a correction, the Fibonacci extension of the impulse determines the target for the correction.
Note that Fibonacci levels are just a prediction tool, there is no guarantee that the price will reach these levels exactly.
The strong relationship between Fibonacci and Elliott waves
The relationship between Fibonacci and Elliot waves is an intersection between two technical analysis tools.
- Wavelength: Analysts often use Fibonacci ratios to measure the length of Elliott waves. For example, wave 3 is usually 1.618 times longer than wave 1, or wave 5 is as long as wave 1.
- Retracement levels: Fibonacci retracement levels (e.g. 38.2%, 50%, 61.8%) often coincide with the ending points of corrections in Elliott waves.
- Price Target: Fibonacci ratios can be used to predict the price target of impulse waves, based on the length of previous waves.
Note:
Neither Elliott waves nor the Fibonacci sequence are perfect forecasting tools. They only provide potential signals and need to be combined with other technical analysis tools.
In short, the Fibonacci retracement sequence and Elliott waves have a complementary relationship in market analysis. Using these two tools in combination helps investors identify potential trading opportunities and manage risk more effectively.
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Combination of Elliott wave and Fibonacci retracement
Combining Fibonacci retracements and Elliott waves is like defining a framework for price movement. This helps establish effective trading strategies. Using Elliott waves, you know the current market cycle and forecast the price trend.
The Elliott wave principle determines the overall shape and structure. While the Fibonacci ratio provides a tool to measure price movements in terms of both amplitude and ending time. Combining the Elliott wave principle with the Fibonacci ratio is an effective scientific method.
The chart presents the classic relationship between the 2nd and 4th waves. Wave ((ii)) reached a level of 0.618, while wave ((iv)) only reached a level of 0.382 of wave ((iii)). Usually, the second wave is closely related to the previous wave. The 0.618 level is the main target for wave 2, but there are exceptions and this guidance is new
The next chart shows the exact example, with both waves ((ii)) and (ii) ending at 0.786, which is the starting point for a down wave. Waves (iv) and ((iv)) only recovered to the 0.236 fib level of the previous third wave. Here is another example of alternation.
Mastering Fibonacci and Elliott waves, traders confidently “read the pulse” of the market and Elliott waves trading more effectively.
Summary
Through the above article, you have grasped what Fibonacci and Elliott waves are and their relationship. Besides, you also know the combination of Fibonacci retracement and Elliott waves in Forex trading. Don’t forget to follow Forex Trading to update useful knowledge about technical analysis in investment and finance.
FAQ
How are Fibonacci retracements and Elliott waves different?
Fibonacci: Provides ratios to determine support/resistance levels and price targets.
Elliott Wave: Describes repeating wave patterns to predict market trends.
Should I use Fibonacci or Elliott waves?
It’s best to combine both. Fibonacci helps measure Elliott waves and identify potential entry points. It is important that you clearly understand the principles of each method. Then apply and combine them effectively.
Are Elliott Waves and Fibonacci always accurate?
Neither Elliott nor Fibonacci waves can be guaranteed to be 100% accurate. Because they are just support tools. You need to combine it with other technical analysis and strict risk management.
