Fibonacci ratios, both retracement and extensions, can be valuable tools in helping you assess areas to enter and exit trades. The exact level isn’t important. Rather, you want to watch for trade signals that occur near key Fibonacci levels. The video below discusses some of the most common (key) Fibonacci levels in financial markets. Looking for trades around these levels may help you in your trading.
If you are unfamiliar with Fibonacci ratios, read Using Fibonacci Retracements to Find Entry Points.
Fibonacci and Elliott Waves are not requirements for successful trading, but some traders do find them useful for zeroing in on potential trades.
By Elliott Wave International
Each Elliott wave pattern has its own common Fibonacci relationships between waves. You can use them to set your price targets and determine where a trend or pullback could end.
In other words, Fibonacci ratios are excellent tools that show you where [approximately] to play close attention for entry and exit signals.
Most Common Fibonacci Correction Levels
The chart above on the left shows a wave 1 followed by corrective wave 2. It is common [not always, it’s just common] for second waves to retrace .618 of wave 1 — thereby making a deep retracement. Another common retracement for wave 2 is .786. You might even see .5, but .618 is more common. [Simplified: When a new trend begins, after the first wave of that trend there is a typically a big retracement because people are scared and unsure of the new trend.]
The chart above on the right shows the most common retracement for a wave 4. Fourth waves will commonly retrace a smaller percentage or .382 of wave 3. We might also see something like .236. [Simplified: once the trend gets going, people are less afraid and want in on the action, so retracements are typically smaller].
Examples of Common Fibonacci Ratios on Corrections
Below you can see an impulsive 5-wave move on the chart of the S&P 500. Wave 2 is an expanded flat. Wave 4 is a zigzag. Let’s look at the retracements that waves 2 and 4 make.
Wave 2 made a deep retracement — close to .618 [we don’t exact the price to stop exactly at the level, we are just watching trade signals in the area]. On the Fibonacci table you can see the .382, .5, .618, and .786 retracements. The .618 retracement comes in at 1087.75 and the S&P low, on wave 2, is 1090.19.
Wave 4 made a shallow retracement of wave 3. It went just beyond the .382 retracement at 1169.1, bottoming at 1163.75.
In a nutshell, this is what we mean when we say that Elliott waves often form corrections in terms of Fibonacci ratios.
By Elliott Wave International
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This article was syndicated by Elliott Wave International and was originally published under the headlines How to Quickly Spot Common Fibonacci Ratios on a Chart and Learn How to Apply Fibonacci Retracements to Your Trading [includes more charts]. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.