Fibonacci and Elliott Waves

Leonardo Fibonacci was a 13th century accountant who worked for the royal families of Italy. In 1242 he published a paper entitled “liber abaci.” The basis of the work came from a two-year study of the pyramids at Gizeh. Fibonacci discovered that the dimensions of the pyramid were almost exactly the same as the golden mean or (.618). Fibonacci is most noted for his Fibonacci Summation Series, this enabled the old world in the 13th century to switch from Arabic numbering (XXIV=24), to the arithmetic numbering (24), that we still use today. Fibonacci was awarded the equivalent of today’s Nobel Prize for his work in mathematics.

Fibonacci Summation Series

The Fibonacci Summation Series takes 0 and then adds 1. Succeeding numbers in the series adds the previous two numbers and so we get 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 to infinity. At the eighth series, by dividing 55 by 89, you have the golden mean: .618. If you divide 89 by 55 you have 1.618.

It may be easier to understand the pattern if you look at it like this

1+1=2, 1+2=3, 2+3=5, 3+5=8, 5+8=13…..

These ratios, and several others which are derived from them, appear in nature everywhere, and in the financial markets they can often indicate levels at which strong resistance and support will be found. Why are they important to the financial markets? Because the markets tend to reverse right at levels that just happen to coincide with the Fibonacci ratios. For example, if the Nasdaq rallies 100 points and then corrects, it will often correct 61.8%, right at, or close to the 61.8%. Fibonacci support and resistance levels can and do fail. There are other Fibonacci levels which may turn the markets (78.6%, 127.2%, 161.8%, etc.). But the fact that it does happen is what is called a trader’s edge.

Elliott Wave was developed by R. N. Elliott as a way of analysing price movements of assets within financial markets. From the analytical perspective, there are two types of waves, the key is to determine the impulsive and corrective waves, first the impulsive waves need to be identified, then the five wave sequence needs to be identified to provide a starting point from which to commence the analysis. A typical wave pattern consists of five up waves in a bull markets, followed by three waves down. The five up waves consists of three impulsive waves, 1, 3 and 5 and two corrective waves, 2 and 4. The correction following the completion of the five waves unfolds in three corrective waves, a, b and c.

Finding a wave pattern that completes at a strong Fibonacci support or resistance level can be a very reliable indicator of a change in the current trend. When an Elliott Wave pattern complete right “at” a Fibonacci support or resistance level, you in essence have increased the probabilities of being correct.

Trading Patterns

Because the markets often move in 5 wave and 3 wave patterns, and the turning points that create these patterns are often at Fibonacci support and resistance levels (61.8, 161.8, etc.). There are several trading patterns which are used by traders, which take advantage of the combined strength of Elliott Waves and Fibonacci retracements. These patterns commonly repeat in stock and index charts and traders who use them are called “pattern traders.” Although pattern recognition is a potent tool in trading they require experience and a thorough understanding to be able to put into a trading plan that is beneficial.

For more detailed understanding the video below provided by binary.com goes into the basics of Fibonacci trading.