Saturday, September 15, 2012

Research: Fib Extensions

During my foray into the mysterious world of Elliot Wave Theory, I was introduced to the importance of Fibonacci numbers. Especially, the relationship between different waves. To my mind, 61.8 and its converse 38.2 were the most often found relationship. I was however applying these relationships to a wave and its retrace. I did not pay much attention to the fib relationships between waves going in the same direction. Not until I was exposed to Wolfe waves a month or so ago. Wolfe waves focus your attention on the Fib extension of the waves. Meaning, if a wave starting from 0, finishes at point A, say 1000, the next wave in the same direction would reach 127.2 or 161.8 extension i.e., 1272 or 1618, regardless of how much the prior wave retraced. This is great from a standpoint of knowing when the market will take a breather or retrace again.

I set about the weekly chart of SPX going back to early 90s to look for the more prolific extensions. Actually, when I started I had a hunch that 127.2 and 161.8 would be predominant but I wanted to back-test my hypothesis anyway.

So, here is what I found



Both the 161.8 and 127.2 Fib extensions do look very promising. Each time I had a 'hit', I put a blue colored ellipse next to it. As you look at the numbers, you realize -
1. Rarely do we get a retrace at the exact Fib number.
2. There is no way to know which one would apply. Is it 127.2 or 161.8 or both.

But here is the promising part-
1. More times than not, there is a breather or retrace at these Fib extensions. If nothing, these are great points to unload at the top and reload at the bottom of the weekly candle.
2. The price action plays a an important role here in differentiating a retrace from a breather.
3. On most occasions, a penetration of the 127.2 fib does not mean that it is not applicable. As a matter of fact, a penetration of that fib but close below it, adds to the importance of that Fib. Often, this is how you see the market taking a small breather.
4. When the fibs of the larger outer waves match the fibs of the inner waves, there is a larger potential of retrace.
5. Consecutive waves in the same direction display a larger degree of correlation. This may not be apparent when the waves are unfolding. But look for correlation between waves of higher or lower degrees.
6. The tape does not always 'touch' the fib extensions. This is especially true of the 161.8 fib extension. Many times, it is shy of the target by up to 10 points on SPX. So, becoming aware of the influence of 161.8 fib extension from 10 points earlier, especially when the length of the wave is long or of a high degree, helps.
7. I noticed that when 127.2 appears to be disregarded by the tape, it becomes a support. So, in cases where the tapes bursts through 127.2 and closes higher, more often than not, it comes back to use 127.2 as a support. A good help in knowing when to reload.

I will expand this list as I identify more items of interest from these charts. The takeaways for me remain the same - 127.2 and 161.8 are important Fib extensions and it pays to give attention to them.

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