14.5 Trading Elliott Waves with Fibonacci Part 2

Elliott waves

Trading Elliott Waves with Fibonacci Part 2 - Text Version

In the last lesson, we looked at applying Fibonacci analysis to trading Wave 3 of an Impulse sequence. In this lesson, we are going to look at applying Fibonacci analysis to the next most popular Wave to trade – and that is Wave 5.

If you want to catch the beginning of Wave 5, you must find the end of Wave 4. Wave 4 tends to have a shallow retracement, so Elliott traders use the lower Fibonacci levels, in particular, thirty-eight point two percent and twenty three point six percent. The Thirty-eight point two percent ratio is found by dividing one number in the Fibonacci series by the number that is found two places to the right, for example, fifty five divided by one hundred and forty four. The twenty-three point six percent ratio is found by dividing one number in the Fibonacci series by the number that is found three places to the right, for example, twenty one divided by eighty nine.

One of the advantages of trading Wave 5 is that the trend is clearly established by this stage. If you enter a little too early, let’s say while the price is still in Wave 3, you still are still trading in the direction of the overall trend. And because Wave 4 often retraces by a shallow amount, the likelihood of your stop-loss being hit is a lot less. However, there are disadvantages to trading Wave 5. Wave 5 can sometimes be a smaller move leaving you with little upside potential. And if you are attempting to trade Wave 5, you are entering at the later stages of a trend making it more likely that the trend will end on you sooner rather than later.

Where should you place the stop-loss when trading Wave 5? As you will remember from the Elliott Wave rules, Wave 4 should not go into the territory of Wave 2. Does that mean it is a good idea to place the stop-loss at the top of Wave 2? That depends on the distance between your entry and the top of Wave 2. You must judge this on each individual trade and make sure you have an acceptable reward risk ratio. Alternatively, you can place the stop-loss below a recent low for a long trade or above a recent high for a short trade.

As you may have guessed from the descriptions of Corrective patterns, few Elliott traders choose to trade them because of their complexity and the fact that corrective patterns, by definition, are not in line with the larger overall trend.

Now you have the foundations for Elliott Wave Theory. Like any part of technical analysis, practice, practice and more practice. Look at different charts on different timeframes and see if they make sense to you through the lens of Elliott Wave. Investigate some of the software solutions out there that can help you find Elliott Wave points on a chart.

And as with any method of trading, practice on a demo account first and always control your risk!

Happy trading!