DailyFX.com -

Article Summary: One forex strategy many traders use is a technical analysis strategy of comparing the length of two alternating waves. Many times, these waves are related in distance by Fibonacci ratios. This is the first of a multi-part series for projecting wave extensions using the Fibonacci expansion tool.

The Fibonacci sequence provides the foundation of trading decisions for many traders through the golden ratio. This is the first part of a multi-piece sequence on trading with Fibonacci ratios in determining price projections.

Fibonacci can be a complicated subject because there are a wide variety of uses and interpretations for it. My objective of the first part of this series is to focus using Fibonacci in alternating waves. Future articles will use the length of alternating waves to aid us in determining entry and exit points of a pair.

To get started, it is important to understand some common wave relationships between the alternating waves. For those who follow Elliott Wave analysis, you may find some of this familiar and a good refresher.

What are Alternating Waves?

In a three wave move, the alternating waves will be wave A and wave C (or if you label with numbers, wave 1 and wave 3). So in the picture below of an uptrend, the alternating waves are the first wave of the uptrend and the 2nd leg of the uptrend which happens to be the C leg of the pattern (the waves colored in blue).

How to Use Alternating Waves in a Forex Strategy (Part 1)

So when referencing alternating waves, we are referring to waves ‘1’ and ‘3’ or waves ‘A’ and ‘C’.

What are the common wave relationships?

There are many ratios that traders use. We will try to keep things simple and focus only on patterns showing a .618, 1.00, 1.618 or 2.618 relationship.

These ratios are derived from the Fibonacci number sequence. The Fibonacci sequence is a numerical series where every number is the sum of the preceding two numbers. Here is an example of the first several Fibonacci numbers:

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc

The ratios mentioned at the beginning of this section are obtained by manipulating the numbers in this sequence.

.618 = Take any number of the sequence and divide it by the number to the right. As this sequence becomes larger, this ratio closes in to .618.

1.618 = Take any number of the sequence and divide it by the number to the left. This ratio closes in on 1.618 as the sequence becomes larger.

2.618 = Take any number of the sequence and divide it by the number 2 positions to the left. This ratio closes in to 2.618 as the sequence becomes larger.

Where is the 1.00 description?

You may have noticed that the 1.00 description was not provided above. The 1.00 is not a part of the Fibonacci sequence (unless you want to get cute and take a number and divide it by itself). However, this 1.00 figure is very important when assessing alternating waves. A relationship of 1.00 means the alternating waves are equal in length which is a common wave relationship.

So if the wave ‘C’ is approaching the 1.00 wave relationship, the 1.00 levels represents the price point where the length of wave ‘A’ is equal to the length of wave ‘C’.

How do I find and draw the Fibonacci levels on the charts?

First assess the direction of the trend. If the trend is up, we want to look for an up-down sequence to draw the Fibonacci levels on the chart. (This would represent waves A and B of the 3 wave move.)

How to Use Alternating Waves in a Forex Strategy (Part 1)

(Created using FXCM’s Marketscope 2.0 charts)

Then, when prices retrace only a portion of the first up leg, this leaves the pair exposed to an upside break to new highs. Therefore, this partial retracement of the up leg becomes the ‘B’ leg of the three wave pattern. We will use the first two waves to estimate potential stopping points for the 3rd leg of the pattern.

In the FXCM Marketscope charts, add the Fibonacci Expansion tool. To draw the levels on the chart first left click and drag from the beginning of the pattern to the end of the first leg (labeled ‘A’) and let go of the mouse button.

Secondly, move your mouse down to the end of the second leg (labeled ‘B’ on the chart) and click again. The tool should automatically draw .618, 1.000, 1.618, 2.618 lines on your chart. These lines represent potential stopping points or resistance areas of the pattern.

If these potential price projections are near other levels of resistance, then we can build confidence in establishing short positions at the resistance zone.We can use the alternating wave relationships to pinpoint potential reversal points. Above, we can see how wave ‘C’ comes very close to reaching the 1.00 (which is the 100%) level then reverses. This means that wave ‘C’ was about the same length of wave ‘A’ which is common in a three wave movement.

Additional Reading: Timing Reversals with Equal Waves (Part 2)

Related Articles
  1. Forex Education

    Four Currencies Under the Spotlight in 2016

    With currencies having become the “tail that wags the dog,” in terms of their impact on the global economy, these four currencies will be under the spotlight in 2016.
  2. Forex Fundamentals

    These Currencies Are The Biggest Losers Of The Stock Downturn

    Here’s a list of the hardest-hit currencies amid the global stock market mayhem.
  3. Forex Strategies

    Will the Euro Continue to Rally? (EUO)

    The euro is rallying. Should investors chase this performance or is the real opportunity on the other side of the trade?
  4. Investing News

    China’s Forex Reserves Dropped Significantly

    China’s forex​ reserves dropped by a record $93.9 billion at the end of August to $3.56 trillion because the Central Bank has been selling dollars to provide a cushion to the falling yuan​
  5. Forex

    The Pros and Cons of a Fully Convertible Rupee

    Amid the rising economic power of India, the talks of making the Indian currency fully convertible are gaining momentum. We look at the pros and cons.
  6. Forex Fundamentals

    Chinese Yuan an Unlikely Reserve Currency

    As the world's second largest economy, China's challenge to America’s dominance includes a push to make the yuan (RMB), the world’s reserve currency. Whether it can do that now is unclear.
  7. Economics

    How Currency Enforcement Helped Sink The Trans-Pacific Partnership (TTP)

    One particular barrier to trade that has received much attention of late and caused delays in negotiations of the TPP is exchange-rate manipulation, by which a country artificially devalues its ...
  8. Forex

    Top U.S Forex News Sites

    Breaking news moves forex markets. Here are the top U.S. sites for tracking forex news.
  9. Investing

    Financial News Comparison: Bloomberg Vs. Reuters (BAC, GOOG)

    Access to financial information has grown with the expansion of digital news. Bloomberg and Thomson Reuters lead the pack, claiming a majority of the business information market.
  10. Economics

    Who Benefits From South Korea's Lowered Interest Rates?

    South Korea is the latest country to cut interest rates in an attempt to stimulate economic growth.
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center