Different Fibonacci Levels Important when Trading with Elliott
Fibonacci levels are extremely important for a correct Elliott count and the patterns Elliott identified are strongly related to these levels. No matter if an impulsive wave or a corrective one forms, Fibonacci levels are the decisive factor to correctly count waves.
Elliott identified many types of patterns that evolve around Fibonacci levels and there are both internal and external Fibonacci considerations when counting waves with the Elliott Waves theory. External considerations refer to the overall place of the pattern in the whole structure, while internal Fibonacci projections refer to either retracement or expansion levels that need to happen in a pattern.
Just to give you an idea, in a contracting triangle, one of the most common patterns defined by Elliott, at least three waves need to retrace minimum fifty percent of the previous wave. Such a rule is an internal one, and it is defining the overall pattern. If there are no three waves to fulfil this rule, that is not a contracting triangle. As simple as that.
As you can see, Fibonacci levels are the pillars of the Elliott Waves theory and the purpose of this article is to list the most important ones, together with the implications that derive from their interpretation.
Fibonacci Levels to Consider
Both Fibonacci retracement and expansion levels are equally important, even though traders are focusing more on the retracement ones. This is happening because of the constant search for the third wave in an impulsive move as this one is considered to be the one that is most of the times the extended wave, hence, the most profitable one to trade.
When talking about Fibonacci levels, it is important to make a clear distinction between retracement and expansion ones. Both categories are used in the correct interpretation and count with Elliott Waves theory, but their application is a bit different.
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Most Important Retracement Levels
As retracement levels are more popular, it is only normal to start with them. Using retracement levels when trading is extremely useful also from a money management perspective in the sense that traders are placing pending orders to specific retracement levels and if those levels are not reached, it means that the corrective wave is not completed, hence no new trade is taken.
This way overtrading is avoided and discipline takes control over the trading account. Usually, the two combined result in the trading account growing.
The Golden Ratio
By far, the most important Fibonacci retracement level is the 61.8% or the so-called “golden ratio”. Fibonacci defined this as the crucial level for almost everything that surrounds us, and it is no wonder it is finding such an important use in the technical analysis field as well.
The 61.8% level is used both in impulsive and corrective waves, but the interpretation is quite different. In impulsive waves, its main use is to find the entry before the 3rd wave, as the standard interpretation is that the 2nd wave will retrace 61.8% of the previous 1st wave.
While the retracement level is alright, in the sense that one should indeed take a trade if the 2nd wave is retracing that much into the 1st wave territory, it is unlikely that the end of the 2nd wave will be nearly the 61.8% level. Most likely is that only part of the 2nd wave, probably the a-wave, ended around the 61.8% and the rest of the 2nd wave will follow.
This is one of the biggest mistakes traders that use Elliott as a trading tool make. However, for whatever the reason, this interpretation, even though most likely to be wrong in almost all cases, is extremely popular.
The golden ratio level is used in corrective waves as well and, as a matter of fact, it defines corrective waves. As you’re about to find out in our future articles, corrective waves are all about 61.8% retracement.
In order to correctly interpret a three-waves structure as a zigzag or a flat pattern, all eyes should be on the b-wave retracement level. If this one is retracing more or less than 61.8% when compared with the previous a-wave, matters the most in deciding if the three-waves structure is a flat or a zigzag.
Moreover, the golden ratio has implications in deciding if a correction is a simple or a complex one. If the move that follow a simple correction is not confirming the correction, it means that market is forming an intervening wave or a corrective wave.
This is the very first sign that a complex correction is about to unfold. Complex corrections are of multiple types, though, and these types are being given by the retracement level the intervening wave reaches.
In other words, the 61.8% level is decisive for the analytical thinking that should be used with Elliott Waves theory. To answer all those questions related to the nature of a move, its type, and interpretation, one will have to use the golden ratio in that process.
50% Retracement Level
The common wisdom when trading with Elliott Waves calls for the 2nd wave to retrace anywhere between 50% and 61.8% into the 1st wave territory and this makes the 50% retracement level an extremely important one. It is by far the most important use of it, and the very next one is to interpret the Fibonacci retracement inside a contracting triangle, like mentioned a bit earlier in this article.
38.2% and 23.6% Retracement Levels
These two are not that popular, but they do have important application when looking to find the end of the 4th wave in an impulsive wave or the b-wave in a zigzag.
If the 2nd wave in an impulsive wave is a complex correction, chances favor greatly that the fourth wave will be a simple one and it will retrace just a bit. Therefore, a good opportunity to trade the fifth wave arises and traders are entering on 23.6% first and then more aggressively on the 38.2% levels.
The b-wave of a zigzag cannot retrace more than 61.8% of the previous a-wave and that makes 23.6% and 38.2% levels good entries for traders that want to ride the c-wave. In a zigzag, the c-wave is always an impulsive wave, and this makes it a wave many traders want to be in.
Expansion Levels to Consider
In order of their importance, the following are the expansion levels to be considered when trading with Elliott Waves theory:
- The 161.8% level. This is the defining level that gives the extension in an impulsive wave, but it has applications in corrective waves as well. Just to give an example, if the b-wave in a flat retraces more than 161.8% of the a-wave, then the c-wave is not possible to break the end of the a-wave.
- The 138.2% level. This is one level that helps differentiate types of flats, as flats are the most divided simple corrections.
- The 123.6% level. Such a level is calculated, again, to make a difference between two types of flat patterns.
The above retracement and expansion levels are the ones the Elliott Waves trader needs to be familiar with. Correct counting greatly depends on these levels.
Other educational materials
- What is Elliott Waves Theory?
- Defining Impulsive Waves
- Defining Corrective Waves
- Use the Fibonacci Extension Tool in Elliott Waves Theory
- Trading Different Types of Extended Waves
- Bill Williams – How to Use Williams Indicators When Trading Forex
Recommended further readings
- Elliott wave principle: key to market behavior, AJ Frost, RR Prechter – 2005
- Using fibonacci numbers to forecast the stock market, R Allahyari Soeini, A Niroomand – International Journal, 2012