Understanding the basics of the mathematical Fibonacci sequence is key to grasping the essence of the Elliott Waves Theory as the two things go hand in hand. One of the ways in which a trader can determine the end of corrections and therefore areas of potential reversal is to use Fibonacci retracement levels in an analytical approach. Fibonacci retracement is one of the most important tools used by investors who favour the Elliott Wave Theory and it is based on the numerical sequence which was devised by Leonardo Fibonacci, a mathematician. The Fibonacci ratios which are considered to be most important for binary options trading are 261.8%, 161.8%, 100%, 76.4%, 61.8%, 50%, 38.2% and 23.6%. When the asset prices move to these specific percentages, traders can assume that certain market actions will take place. In order to identify the correct retracement area, a trader must take into account a number of things including market correlation and previous wave structure.
Common Relationships in the Elliott Wave Theory With Fibonacci Levels
Usually, wave 2 will be either 50% or 61.8% of the first wave, while wave 3 will be either 161.8% or 261.8% of the first wave. Wave 4 is either 38.2%, 50% or 61.8% of the third wave, while the fifth wave will be either 100% of the first wave, or 161.8% of the fourth wave. Wave A can be either 50%, 61.8%, 100% or 161.8% of the fifth wave, while wave B will be either 61.8% or 50% of wave A and wave C will be either 161.8% or 100% of wave A or 161.8% of wave B.
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When Fibonacci levels are combined with the Elliott Wave structure, the trader can glean a wealth of information about highly probably turning points as well as an ideal about where the next price move is probably going to terminate. Therefore being able to apply the right Fibonacci levels and counting waves are essential to be a successful Elliott Wave trader.
How to Trade the Elliott Wave Theory With Fibonacci Levels
When using the Elliott Wave Theory, the most powerful wave to be aware of is the third wave, and this is widely believed to be the best wave to trade. To identify it correctly, a trader first has to find a first wave in the direction of a newly developing trend which is then followed by wave 2 which will be a corrective wave and which will cover either 61.8%, 50% or 38.2% of the first wave. Once both of these waves have been observed and confirmed, an investor is then able to try to anticipate where the third wave will begin. Often at the start of the third wave, a trader may also see a Harmonic pattern which will ususally be either a Bat or Gartley formation.
As well as third wave, the fifth wave is also a good opportunity for binary options trading and it will reach somewhere between 50% and 161.8% of the fourth wave, often being the same size as wave 1.
The fifth wave and the third wave represent the two impulsive Elliott Waves which are able to be traded. Both these waves form during the trend phase and it is important to remember that the general trending move will also create two corrections. These are more difficult to trade and only offer small profit opportunities however.
Once the trend phase that ends with the fifth wave has been completed, it is possible to anticipate the A, B and C waves of the general correction which occur within the corrective phase, and of these, wave C is probably the best option for trading. This is because it is the most powerful of the corrective waves, with a number of similarities to the Impulsive wave 3. Usually, a trader should wait for the 50% to 61.8% retracement of the A wave before entering into the emerging move of Wave C.
Other educational articles
- Elliott Waves – Tips And Tricks For Trading 3rd Waves Extensions Impulsive Moves
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- Fuzzy time-series based on Fibonacci sequence for stock price forecasting. Chen, T. L., Cheng, C. H., & Teoh, H. J. (2007). 380, 377-390.
- The applications of the Fibonacci sequence and Elliott wave theory in predicting the security price movements: a survey. Chatterjee, A., Felix Ayadi, O., & Maniam, B. (2002). Journal of Commercial Banking and Finance, 1, 65-76.