How to Use the Fibonacci Expansion Tool in Elliott Waves Theory
The whole Elliott Waves theory is based on the Fibonacci levels and sequences and it is not possible to count wave or to trade with Elliott if no Fibonacci levels are involved. Trading platforms acknowledged this and they are all offering all kinds of Fibonacci tools for the everyday trader to use.
The most popular one by far is the Fibonacci Retracement tool as it is allowing traders to look at the exact retracement level a market reaches and based on that level, future patterns can be identified. In Elliott Waves theory, the Fibonacci Retracement tool has great application when interpreting the 2nd and the 4th waves in an impulsive wave, as well as the overall a-b-c corrective structure that follows a five-waves impulsive move.
Fibonacci Expansion is another technical analysis tool used in strong relation with Elliott Waves theory as, like mentioned in the previous articles dedicate to this trading theory, in a five-waves structure, at least one wave needs to be extended. This extension can be effectively calculated with this Fibonacci Expansion tool and offers both a target for the opening trades, as well as the right labeling.
Fibonacci Time Zones is also widely used with Elliott Waves theory as this trading theory is one of the few ones that allows a trader to incorporate the time element into any price forecast. Time is as important as price and Elliott offer invalidation of specific counts if time is not respected.
Unfortunately, there are few Elliotticians that know how to incorporate the time element and therefore the Fibonacci Time Zones is not that popular. However, it represents a must in order to rip all the benefits the Elliott Waves theory can offer.
These three Fibonacci trading tools are the only ones that are used together with the Elliott waves theory and are offered by the MetaTrader 4 trading platform as well. On top of them, Fibonacci Fans and Arcs tools are also present, but they have applications and interpretations in other areas.
Searching for the Extended Wave
Because any impulsive wave or a five-waves structure is mandatory to have at least one extended wave, traders are struggling to find it in order to position for the move that is about to come. Everyone wants to ride the extended wave as it is one wave that appeals to the overall trading motivation: quick profits as fast as possible. The extended wave can offer that, and much more.
Finding the extended wave is not an easy task, though. It requires a lot of knowledge and correct market interpretation for the moves prior to the extended wave and, moreover, attention to details.
Assuming a trader believes an extended wave in a five-waves sequence is forming, there are several things to do in order to find out the target for the move to follow. The key to correct market interpretation comes from the Fibonacci Expansion tool.
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Projecting the 3rd Wave
The article dedicated to defining impulsive waves had mentioned the fact that the 3rd wave is the one that is most likely to be extended. That means that a trader has an idea about the minimum distance that the 3rd wave will travel already by the time that the 1st wave ended.
At that moment of time, it is not possible to know the length of the 5th wave (actually we may already have an idea about its length, but this to be explained later) and therefore the projected 3rd wave will be calculated based on the length of the 1st wave. To do that, traders use the Fibonacci Expansion too.
The first thing is to select the Expansion tool and click at the start and end of the 1st wave. Moving forward, the way to go is to drag the third point of the Expansion tool at the end of the second wave.
The result is a projected 161.8% level that starts from the end of the 2nd wave. That is the minimum distance for the 3rd wave to travel in order for it to be considered an extended wave in an impulsive move.
Please consider that usually extended waves are explosive move, and this comes to explain why traders are keen to position themselves ahead of such a move. The 161.8% extension level is actually one the minimum level to be reached, but often extensions go all the way to 261.8%, and even 461.8% or more. This is how important is to ride the right wave!
If these extended levels are not offered by the Fibonacci Expansion tool, they can be easily added. To do that, just select the tool, right-click, chose the Properties tab, and under the Levels tab, any value can be added.
How to Actually Trade with Fibonacci Expansion Tool
Now that we know how to find the extended wave with the Fibonacci Expansion tool, the very next question is how to actually trade? How to profit from the Forex market from this powerful statement?
To answer that question, it is time to put everything we learned so far on the Elliott Waves subject here on Forex Trading Academy. Remember that any trade taken should be the result of a due diligence process that leads to one and only one right decision.
We know by now that the 2nd wave is not possible to retrace beyond the start of the first wave. This is one of the defining rules of impulsive waves we discussed earlier in this project. Hence, any trade one might take should have a stop loss at the level where the first wave started.
The entry level can be based either on a Fibonacci retracement level, like 38.2% or 50% retracement of the first wave, or traders can use pending orders to enter by the time market is moving beyond the end of the first wave. So far we have the entry and the stop loss, but how about the take profit?
This one should be interpreted based on the 161.8% extension that was mentioned earlier in this article. However, considering that the 161.8% is the minimum level to come for a wave to be considered extended, in reality, the market may travel way beyond that level.
To avoid exiting too early from the right trade, a trailing stop order can be used. Such an order should be set up in such a way that its activation should make sure that the extended wave is completed.
Other educational materials
- What is Elliott Waves Theory?
- Defining Impulsive Waves
- Defining Corrective Waves
- Different Fibonacci Levels Important When Trading with Elliott
- Trading Different Types of Extended Waves
- Bill Williams – How to Use Williams Indicators When Trading Forex
Recommended further readings
- The applications of the Fibonacci sequence and Elliott wave
theory in predicting the security price movements: a survey, Amitava Chatterjee, Ph.D., cs
- Mastering Elliott Wave Principle: Elementary Concepts, Wave Patterns, and Practice Exercises, Constance Brown, John Wiley & Sons, 2012