Candlesticks, Fibonacci, and Chart Pattern Trading Tools : a synergistic Strategy to Enhance Profits and Reduce Risk

Figure 3.6
Extensions out of a regular 3-wave pattern and a bear trap chart
formation.
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FIBONACCI ANALYSIS
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3. The resulting value is added to the size of the initiating swing to
def ine the price target.
Figure 3.7 illustrates these steps.
Sophisticated investors who want to explore fast markets can eas-
ily follow the basic principles of extensions in 3-wave patterns and ex-
tend the rules into 5-wave price patterns.
Price Extensions in 5-Wave Patterns
When analyzing price extensions in a 5-wave pattern, we look for an
additional parameter from the Fibonacci summation series to conf irm
our price target calculation for extensions out of a 3-wave pattern
based on the 1.618 ratio.
To analyze a 3-wave price pattern, we multiply the size of the
f irst impulse wave by the Fibonacci ratio 1.618. The product is then
added to the swing size of the initial move to calculate the Fibonacci
price target line. It is at this Fibonacci price target line that we expect
the third wave to reverse.
Figure 3.7
Extension in the third wave of a 3-wave pattern uptrend. Target level
measured by the Fibonacci ratio PHI
=
1.618.
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BASIC PRINCIPLES OF TRADING STRATEGIES
Because there are usually more than three waves in a trending
market, we need to modify our calculations for the Fibonacci target
price. The most common price pattern has at least f ive waves: three
impulse waves and two corrective waves.
A target price line in a typical 5-wave market price pattern is
shown in Figure 3.8.
In a regular 5-wave move in an uptrend, the price target line for
the end of wave 5 is calculated by multiplying the amplitude of wave
1 by the Fibonacci ratio 1.618, and then multiplying the amplitude
from the bottom of the wave to the top of wave 3 by the reciprocal value
to the Fibonacci ratio 0.618. In a downtrend pattern, we also multiply
the initial swing size by 1.618 and multiply the amplitude from the
high of wave 1 to the low of wave 3 by the ratio 0.618.
By combining the two calculations—using ratios 0.618 and
1.618—we can precalculate the end of wave 5 at the same price, given
that the market moves in a regular price pattern as described.
In practical terms, however, this is seldom the case. Instead of
f inding the same price level with both ratios, we get two price levels
that are closer together or wider apart, depending on the amplitudes
of wave 1 and wave 3. We f ind an upper and lower price target, de-
f ined as a Fibonacci price target band.
Do we know whether this price forecast will ever be reached? Ab-
solutely not. But we know in advance whether the price band calcu-
lated at 1.618 times the size of wave 1 and at 0.618 times the distance
from the top or bottom of wave 1 to the bottom or top of wave 3 will
be close together or far apart. If the price target band is far apart, we
do not use it for the analysis. A band is worth consideration if its