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

DailyFX

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).

View gallery

.
How_to_Use_Alternating_Waves_in_a_Forex_Strategy_body_Picture_1.png, 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 261.8% 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.)

View gallery

.
How_to_Use_Alternating_Waves_in_a_Forex_Strategy_body_Picture_4.png, 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)

---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education

Follow me on Twitter at @JWagnerFXTrader.To be added to Jeremy’s e-mail distribution list, click HERE and enter in your email information.

To learn more about the Fibonacci ratios and how to use them in partial retracements, register for this free Fibonacci course that will take about 20 minutes to complete.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Learn forex trading with a free practice account and trading charts from FXCM.

Rates

View Comments (0)

Recommended for You

  • Tycoon buys 30 Rolls-Royces for Macau hotel

    A Hong Kong tycoon has placed the biggest ever order for Rolls-Royce cars, agreeing to buy 30 Phantoms to chauffeur guests at a luxury resort he's building in the global gambling capital of Macau. Stephen Hung's $20 million purchase surpasses the 14 Phantoms bought by Hong Kong's Peninsula Hotel in…

    Associated Press
  • 7 Bones the Queen Wants to Pick with Pippa

    We knew the Queen had a few bones to pick with Kate Middleton, so it should come as no surprise that she also has some reservations about Pippa.

    AdChoicesAnswers PopSponsored
  • Before You Buy Alibaba, Check Out 4 Top China Stocks

    Before You Buy Alibaba, Check Out 4 Top China Stocks While investors gear up for Alibaba Group 's (BABA) hotly anticipated initial public offering, don't forget about other Chinese stocks that are worth keeping an eye on. Today's Young Guns Screen of

    Investor's Business Daily
  • "The Retiree Next Door": How successful retirees stretch their savings

    "The Retiree Next Door": How successful retirees stretch their savingsBy the time she hit her late 40s, Toni Eugenia wasn’t sure she would ever be able to retire. Eugenia, 56, a pharmacy technician who lived in Houston, was nearly $200,000 in debt and

    Yahoo Finance
  • CNBC Anchor Calls Out Fed-Hater Bill Fleckenstein In Startling Shouting Match

    CNBC Bill Fleckenstein of Fleckenstein Capital appeared on CNBC's Futures Now program on Tuesday. Futures Now host Jackie DeAngelis came out swinging, asking Fleckenstein right at the top if he was willing to admit that he had misunderstood monetary policy. Sounding taken aback, Fleckenstein…

    Business Insider
  • Apple to unveil new iPads, operating system on Oct. 21 : report

    The company plans to unveil the sixth generation of its iPad and the third edition of the iPad mini, as well as its operating system OS X Yosemite, which has undergone a complete visual overhaul, the Internet news website said. Trudy Muller, a spokeswoman for Apple, declined to comment. The iPad is…

    Reuters
  • Margaritaville casino owners seek bankruptcy

    The owner of Biloxi's Margaritaville casino has filed for Chapter 11 bankruptcy protection Tuesday, only hours before a hearing where the landlord aimed to seize the property. The filing by MVB Holding LLC in U.S. Don Dornan, a lawyer for landlord Clay Point LLC, said the company had planned to ask…

    Associated Press
  • Embraer to sell 50 E-175 jets to Republic in $2.1 billion deal

    Brazil's Embraer SA, the world's third largest commercial planemaker, said on Wednesday it booked a firm order from U.S. The deal, which will be included in Embraer's order book for the third quarter, is valued at $2.1 billion, the planemaker said in a securities filing. The planes will be operated…

    Reuters
  • Are You Wondering What Your Current Car is Worth?

    Black Book is an online leader in offering timely, independent & accurate used car values. Get trade-in value from Black Book & a new car price quote!

    AdChoicesNewCars.comSponsored
  • Play

    Citi, Bank of America Offer Discounted Mortgages

    Citigroup and Bank of America will offer mortgages at discounted interest rates to help borrowers with low incomes or subprime credit. AnnaMaria Andriotis joins MoneyBeat. Photo: Getty.

    WSJ Live
  • Here's What Mark Cuban Wishes He Knew About Money In His 20s

    Cuban is the owner of the Dallas Mavericks basketball team. Billionaire investor and entrepreneur Mark Cuban is generous with his advice. When we asked him what he wishes he'd known about money in his 20s, he said:

    Business Insider
  • Gold loses luster on Fed; Barclays cuts forecast

    Barclays cuts gold forecasts, sees increasingly bearish backdrop Bloomberg MA MB MC MD ME SAN FRANCISCO (MarketWatch) — Gold prices dipped Wednesday on concerns about a stronger dollar ahead of the Federal Reserve policy statement and in response to Barclays lowering its gold forecast.

    MarketWatch
  • Gilead Stock Is Falling On These Drug Setbacks

    Gilead Stock Is Falling On These Drug Setbacks Gilead Sciences (GILD) shares are backsliding Wednesday on news that the patient drop-out rate for hepatitis C drug Sovaldi is quadruple that of clinical trials. In addition, the biotech's Phase 2 study results

    Investor's Business Daily
  • Play

    What the Fed Meeting Means for Bonds

    Janet Yellen & Co. are expected to hint at their timetable for raising interest rates. Here's how investors should prepare ahead of the meeting.

    WSJ Live
  • SHOE COMPANY: Our CEO Just Disappeared And Most Of The Money Is Gone

    "and like that: he's gone." This is an actual headline from a company press release: "CEO and COO disappeared, most of the company's cash missing." (Via FastFT) In a statement, German-based shoe company Ultrasonic said its CFO,  Chi Kwong Clifford Chan, has been unable to reach the company's CEO,…

    Business Insider
  • Search People's Exposed Past Through New Site

    Discover more info about someone's past like bankruptcies, addresses, social profiles & more. Simply enter a Name and State! See what you can find.

    AdChoicesBeenVerified Inc.Sponsored
  • Top Analyst Upgrades and Downgrades: AEP, BHP, GE, Incyte, 3M, Tyco, Under Armour and More

    Top Analyst Upgrades and Downgrades: AEP, BHP, GE, Incyte, 3M, Tyco, Under Armour and More Stocks were firm on Wednesday morning ahead of the FOMC meeting outcome. Tuesday’s rally may have sparked higher interest again, and investors are looking for bargains

    24/7 Wall St.
  • Billionaire Investor Says Chinese People Work Harder And Western Companies Could Face Deep Trouble After Alibaba IPO

    Michael Moritz, the chairman of VC firm Sequoia Capital, is a huge fan of Chinese internet companies and reiterated his enthusiasm for the Chinese market in an interview with The Wall Street Journal Wednesday. The billionaire investor described the Alibaba IPO as a “major landmark event” that is as…

    Business Insider
  • 6 Things Debt Collectors Wish You Knew

    The work debt collectors do is not popular, and has become increasingly derided by those who don’t like what we do or simply don’t know the facts about debt collection. Too often, debt collection is painted with a broad brush to create a portrait that isn’t accurate, and doesn’t properly educate…

    Credit.com
  • Boeing may have outfoxed Musk, but it could have bigger problems

    Elon Musk is arguably one of the greatest entrepreneurial minds of the 21st Century, but he was outsized an old school aerospace giant. Boeing won the bulk of NASA’s contract for a space taxi.  One of the other companies vying for the deal is SpaceX, the company headed by Tesla’s Musk, will get a…

    Talking Numbers
  • Romney-Sized IRAs Scrutinized as Government Studies Taxes

    The preliminary report attaches data to an issue that drew attention during the 2012 presidential campaign, when Republican nominee Mitt Romney reported an IRA worth $20 million to $102 million. Senate Finance Committee Chairman Ron Wyden said many of these "massive" accounts come from deals…

    Bloomberg
  • The Government Keeps Helping People Buy Failing Cold Stone Creamerys

    Would you loan someone money to buy a Cold Stone Creamery franchise if you knew that more than a quarter of those loans default? Over the last decade, franchisees in the Cold Stone Creamery ice cream chain defaulted on 29 percent of working-capital loans backed by the government, costing taxpayers…

    BusinessWeek
  • Insurance for Cars Used Less Than 35 Miles a Day

    If you are currently insured, drive less than 35 miles/day or have no DUI's, you qualify for the lowest possible insurance rates offered in the U.S.

    AdChoicesComparisons.orgSponsored
  • Russian billionaire placed under house arrest

    A billionaire Russian tycoon was placed under house arrest Tuesday in a money-laundering case that has drawn comparisons with a government crackdown on Russia's Yukos oil company more than a decade ago. The Investigative Committee, Russia's top investigative agency, said that Vladimir Yevtushenkov,…

    Associated Press