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EWT Lesson 4: Fibonacci Relations of Impulse Waves

• In addition to the wave structure, Fibonacci relations between sub-waves are very important for properly identifying and counting waves.

• Consider Qualcomm (QCOM) chart as a typical example of a wave structure with all actionary waves comprising impulses, i.e. no leading or ending diagonals.

• I placed Fibonacci lines over corrective second and fourth waves, as we are not interested in them in this example.

• Consider the primary 1, circle-1, on the left with alternate color Fibonacci likes.

• We can see that intermediate wave 3, (3), is the longest, which is typical. We can also see that the end of wave (4) does not overlap the range of wave (1), as per Elliott Wave rules for impulses.

• Now consider Fibonacci expansions of wave (1)-(2). We can see that wave (3) and (5) slightly exceed Fibonacci levels 161.8% and 200%. That is close to one typical wave relationship case. I will refer to it as Type 2.

• Consider next wave (1) to the right of circle-1 with red Fibonacci expansion lines of 1-2.

• Wave 3 end at exactly 138.6% fib and wave 5 ends at approximately 161.8% fib. This can be categorized as another wave relationship type. I will refer to it as Type 1.

• Consider next wave (3) to the right with blue Fibonacci lines. Wave 3 slightly exceed Fibonacci level 161.8% and wave five hits almost exactly the 200% fib. Thus, we can categorize it into Type 2.

• On the far right we have green Fibonacci lines which are expansions of primary 1 and 2. We can see that primary 3, circle-3 ended at the 138.6% fib. Thus, we could assume that circle-5 will hit approximately 161.8% fib.

• These patterns repeat in many stocks and financial instruments and represent one of the predictive elements of Elliott Wave Theory. For example, we know that in a trend we need to have 5-wave structures before a bigger correction. After 1-2, we should still expect 3-4-5. After presumed 1-2 one can enter a long trade to capture typically the biggest move in wave 3. To protect oneself against incorrect counting assumptions, a stop can be placed just below the origin of wave 1.

• Another predictive aspect revealed by this example is that after wave 3 is completed one knows where wave 5 should end to set a sell target, if one wants to avoid a drawdown due to a subsequent correction.

• Fibonacci relations together with the wave structure help to identify sub-wave faster and more reliably. But it is not always easy as sometimes one or more waves can be very small and especially when corrective waves are small it is harder to delineate sub-waves. 

• Consider the second wave segment, intermediate 1, (1), after circle-1. It is easy to identify waves 1, 3 and 5 from the structure and Fibonacci levels. But wave 3 looks like 3 wave, which we would not expect. One could guess waves circle-iii-iv-v within 3, but where are circle-I and circle-ii as all retracements are very small. In cases like this one must zoom in and examine waves carefully. For example, look for initial five waves up as a candidate for circle-i such that there are additional five waves to the top of circle-iii, with proper wave relationship.

• Momentum indicators, such as RSI, can also help to identify some of the sub-waves.

• Wave 3 of (3) usually have the peak momentum and RSI has the highest value. For example, typically 3 of (3) has a higher RSI value than 5 of (3), which has a higher RSI value that (5). You can easily see this in QCOM chart in wave circle-1. RSI is declining between peaks of 3, (3) and (5), which is so called negative divergence. We do not want to exit a stock immediately after its peak RSI/momentum, as we should still get higher prices with weakening momentum. Classical technical analysis recognizes that a peak should occur sometime after negative divergence. With EWT we know much more. There a small pullback, there should be another up-down-up sequence, e.g. (3)-(4)-(5), and, moreover, with Fibonacci relationships we know at which levels (3) and (5) should approximately occur.

• Consider next another chart busy with Fibonacci lines and showing idealized 5-wave impulses of Type 1 (black) from the QCOM example and Type 3 (blue), which also often happens in real examples but we did not see it in QCOM chart. Type 3 has a longer wave 3, and wave 5 extends higher than in Types 1 and 2.

• The green fibs are expansions of 1-2 and will be used for both Type 1 and 2 considerations. Red fibs are retracement fibs for wave 1. Blue fibs are retracement fibs for wave for in Type 1, and alternate color fibs are for retracement fibs for wave 4 in Type 3.

• An “ideal” retracement of wave 1 in wave 2 is 61.8% and most of the time in the range 50%-78.6%. In rare instance wave 2 can be very shallow or very deep. The former sometimes happen in wave 2 of (3), while the latter sometimes occurs after a reversal of a prolonged move, say a reversal from a bear trend when many investors think the bear market is still in progress. I observed a rare instance of wave 2 retracing about 98%-99% of wave 1. In the next lesson I will show you an extremely shallow wave 2 in Bitcoin. Remember the rule that wave 2 cannot drop below the origin of 1.

• An ideal retracement of wave 3 in wave 4 is 38.2%, and much of the time can between 23.6% and 50%. Remember the rule that the end of wave 4 cannot enter the territory of wave 1 in impulses. Though some small overlap is occasionally observed in futures.

• Now let me turn your attention to another important predictive relationship. On the left of the chart, you can see stacked bars representing the length of wave 1.

• You can see that the height of wave 5 in Type 1 is equal to 2X length of 1. Type 1 is typical of shorter 5-wave structure.

• You can also see that the height of wave 5 in Type 3, a typical longer 5-wave structure, is equal to 3X length of 1.

• This is a very useful tool in that after the completion of wave 1 we can estimate that most of the time the peak of wave 5 will be in the range of 2X-3X the height of wave 1.

• Occasionally, there are deviations from these three types in that the 5-wave structure can somewhat shorter, or longer. For example, in commodities the wave 5 can be very long and sometimes reach the 423.6% fib.

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  • Tom McClellan found a similarity between S&P 500 pattern now and in the 1978-81 period, suggesting how a potential bear market in SPX may resemble the 1978-81 pattern (upper window).

  • The lower window shows an SPX daily cycle composite comprising several dominant cycles from the daily SPX chart.

  • The striking similarity between the turning points (a-e) in the shifted 1978-81 pattern and the cycle composite is mind boggling.

  • It is suggestive that although cycles may vary over time they are always there.

  • Is this coincidence or something deeper? You judge.

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