Learn the Basics of Corrective Waves
Jeffrey Kennedy of Elliott Wave International (EWI) outlines three important Elliott wave patterns, using Cliffs Natural Resources Inc (CLF), iShares Russell 2000 Index (IWM) and Direxion Daily Financial Bull 3X Shares (FAS) as examples. Watch this 5-minute video excerpt from Kennedy's Trader's Classroom service.
In EWI's discussion below, corrective waves (retracements) are analysed using Fibonacci numbers — the numerical language of the Elliott Wave Theory.
Apply Fibonacci Retracements to Your Trading
Fibonacci is the mathematical basis of the Wave Principle. You will often find that Elliott waves correct in terms of Fibonacci ratios. The following article explains what you can expect when a market begins a corrective phase.
Retracements — Corrective Waves
Figure 1
The chart on the left of Figure 1 shows a wave 1 followed by corrective wave 2. It is common for second waves to retrace 0.618 of wave 1 — thereby making a deep retracement. Another common retracement for wave 2 is 0.786. You might even see 0.5, 50%, but 0.618 is more common. The chart on the right of Figure 1 shows the most common retracement for a wave 4. Fourth waves will commonly retrace a smaller percentage or 0.382 of wave 3. We might also see something like 0.236.
Examples
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 0.618. On the Fibonacci table you can see the 0.382, 0.5, 0.618, and 0.786 retracements. The 0.618 retracement comes in at 1087.75 and the S&P low is 1090.19.
Wave 4 made a shallow retracement of wave 3. It went just beyond the 0.382 retracement at 1169.1, bottoming at 1163.75.
In a nutshell, this is what we mean when we say that Elliott waves often correct in terms of Fibonacci ratios.
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Free resources from EWI:
1. The Elliott Wave Basic Tutorial is a 10-lesson comprehensive online course: Get 10 free Lessons on The Elliott Wave Principle that Will Change the Way You Invest Forever.
2. To learn more about Fibonacci and how to apply it to your trading strategy, download How You Can Use Fibonacci to Improve Your Trading.
3. Also download EWI's free report: "How The Wave Principle Can Improve Your Trading." Kennedy explains the value of EW principles in analyzing your trading decisions and improving your results.
