Advanced Technical Analysis in FX. Fibonacci Retracements, Elliot Wave Theory, Gann Fan and Andrew’s Pitchfork. Paul Brittain Alaron Trading 1-800-935-6492 Pbrittain@alaron.com. Fibonacci.
Fibonacci Retracements, Elliot Wave Theory, Gann Fan and
Fibonacci retracement percentages correspond to natural ratios discovered by the Greeks. They referred to the phenomenon as the Golden Ratio. The theory was then rediscovered by Fibonacci; a medieval, Italian Mathematician.
As displayed in the following slide, these retracement levels are a common occurrence in the ebb and flow of a market trend.
Fibonacci proved that the Golden Ratio is present in many aspects of nature and science, and Elliott felt that it had great significance on the financial markets as well.
Commodity prices will frequently consist of an initial wave, a second wave (often retracing 61.8% of the initial move), the third wave (usually the largest), then another retracement, and finally the 5th wave (the last gap), which would exhaust the movement.
The Fibonocci Ruler is the most commonly used retracement measuring tool. Each level of the ruler highlights the areas in which the market may experience support or resistance.
The market will often reverse its coarse at these retracement levels. Notice the reversal points on the next two slides.
The Elliot Wave Theory was developed by Ralph Nelson Elliot. This theory is based on the premise that market behavior is based on waves rather than random timing.
Elliot believed that prices fluctuated in a series of waves based on the Golden Ratio, also referred to as the Golden mean that was originally proven by Fibonacci.
Elliot believed that the market rises in a series of 5 waves and that a market declines in a series of 3 waves.
According to the theory, on the first wave a market rises, on wave two it declines, begins to rise again on the third wave. The third wave is followed by a period of decline known as the fourth wave, and finally completes the rise on the fifth wave.
There is a correction period following the five wave sequence. This declining period is referred to as a three-wave correction. During this time the market theoretically declines for wave A, begins to rise for wave B, and falls again for wave C.
Wave one: Normally very short and easy to miss.
Wave two: A retracement wave, usually gives back all or most of what the first one gained.
Wave three: Usually very prominent, as it follows a period of what appears as consolidation, most people trade this wave.
Wave four: Noted to be very intricate yet still a consolidation. One of Elliot’s main rules is that in a 5-wave advance cycle, wave 4 can’t overlap wave 1.
Wave five: Often very active, yet at some point declines and leads to the 3 wave corrective cycle.
Three Wave Decline:
Wave A: Normally seen as a minor pullback, of wave 5 of the advance cycle.
Wave B: Follows Wave A of the downtrend, and is often hard to spot but should result in a third wave continuing down.
Wave C: Usually quite significant and many traders see this selling opportunity.
Dr. Alan Andrews developed a channel technique to identify areas of support and resistance from a common baseline. The premise of the theory is to trade the channel depicted by the “tines of the pitchfork.
The center tine begins at the most recent contract high or low. The top tine is determined by looking at the highest move from the contract high or low. The next point is located based on the retracement of that move.
Support tine identified by retracement of the original move
W.D. Gann designed several techniques for studying price charts. He believed that specific geometric patterns and angles contained reoccurrences that could be used to predict price action.
Gann believed that the ideal balance between price and time exists within a 45 degree angle of the axis. The Gann fan is made up of 9 angles and is based on this concept.
The corresponding lines represent support and resistance, once one line is broken by the entire day’s price range the next line becomes new support or resistance. The drawing of these lines should begin at a relative top or bottom of a market.
It is also imperative that when drawing the Gann Fan, the 45 degree angles are kept in tact. In other words the center line should keep a 1 to 1 slope.
During an uptrend, the penetration of one line suggests that the market will rally to the next, in a downtrend a broken support line anticipates a drop to the next line.