Timing Forex Reversals with Equal Waves (Part 2)
Article Summary: The Fibonacci equal wave pattern provides us at least a 1-to-2 risk-to-reward ratio trading opportunity. Below, we provide two examples of how you can incorporate the equal wave pattern into your current forex strategy and technical analysis.
One of the things I love about the FX market is that there are many different ways to trade it. Some traders look for simple methods while others seek out more complex strategies. I have found that alternating equal waves is a good supplement to other forms of forex technical analysis.
Previously, we introduced the concept of alternating waves and the structure of what it looks like. However, just like when using Fibonacci retracement levels, there are many levels to focus on when measuring alternating waves which in the end can create confusion. To bring more confidence to your entries, focus on the one ratio which delivers alternating equal waves.
When applying the Fibonacci expansion tool to the FXCM Marketscope charts, the waves are equal at the 1.00 level. Let’s open the box on how we can use this level to anticipate price reversals so we can time entries into new positions.
Remember, the objective of the equal wave pattern is to anticipate where wave C might terminate. Therefore, we draw on the Marketscope charts using the Fibonacci expansion tool connecting the beginning of wave A to the end of wave A, then connecting the end of wave B. So while using the Marketscope charts Fibonacci expansion tool, it requires 3 points to draw the pattern.
GBPJPY Carves an Equal Wave Pattern
The GBPJPY has been trending to the upside, so let’s look to the equal wave pattern to time potential reversal zones to buy into this uptrend.
Learn Forex: Fibonacci and Price Channels
(Created using FXCM’s Marketscope 2.0 charts)
Notice in the above pattern for the GBPJPY how the equal wave relationship placed a support zone near 140.11. Incorporating other forex technical analysis we can see two additional points of support converging near the similar price zone.
The black price channel shows support near 139.82. Meanwhile, a previous swing low (green circle) occurred at 139.37. Therefore, with several different points of support all converging near the same price zone AND wave C equals the length of wave A in the same area I can feel confident in the approach of buying the pair in this support zone. If you would like additional levels of confirmation, then you can apply candlestick analysis or use an oscillator to time your entry. In essence, the equal wave pattern suggests levels where prices are likely to see a reaction and pivot.
Equal Wave and Elliott Wave Theory
For those who understand Elliott Wave theory, a simple A-B-C move where wave A equals the length of wave C may look familiar to you. A pattern where wave A equals the length of wave C implies it is a corrective move and the whole pattern is likely to be retraced. In the example above regarding the GBPJPY, prices eventually broke to new highs. So if a trader correctly bought in the support zone with a wide enough stop loss to absorb the market’s natural breathing, the potential for upside on the trade would have been a new swing high, nearly 400 pips away.
No Pattern is Perfect
You’ll notice in the GBPJPY chart above, prices did not stop at the equal wave length at 140.11. In reality, prices briefly penetrated lower before making the bounce higher. Patterns rarely play out in textbook fashion so don’t be confused if you never seem to find prices stopping exactly at the equal wave length. The equal wave pattern essentially helps you identify higher probability trades with good risk-to-reward ratios associated with them. Let’s look at another example on the NZDJPY.
Fibonacci Retracements and Fibonacci Expansions
A question we often get regarding the Fibonacci retracement levels is how do you know which fib line to trade?
[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.]
Well, if you practice measuring out equal waves, you can use the Fibonacci expansion tool to help focus on a particular retracement level.
Learn Forex: Converging Support with Fibonacci
(Created using FXCM’s Marketscope 2.0 charts)
In the NZDJPY above, notice how the equal waves level (the blue 1.00 line) is very close to the 50% Fibonacci retracement line (orange line). Additionally, this support zone is close to the support zone offered by the black price channel. So visually, we can see a cluster of support forming on the chart.
The last piece of confirmation with this trade includes how the CCI indicator is showing divergence. This simply means the momentum is losing steam as prices enter this support zone. Therefore, we have a trade set up incorporating several difference pieces of technical analysis.
Since this is an equal wave pattern, you’ll want to place your stop loss just below the swing low and target at a minimum a new swing high. In this case it would be risking about 75 pips for the potential reward of 300. It is not uncommon for this pattern to produce at least a 1-to-2 risk-to-reward ratio. (Learn more about risk to reward ratios and profitability in our Traits of Successful Traders research.)
Suggested Reading: How to Use Alternating Waves (Part 1)
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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(To learn how to trade using CCI, register to take this free CCI course and at the end of the course, receive a Day Trading strategy that uses CCI.)
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