Trading Crypto When Charts Fail: How To Use Elliott Waves and Fibonacci Retracement Instead

In this article, we dive deep into the advanced concepts and techniques employed in the technical analysis of cryptocurrencies. We'll be witnessing how the market moves in waves, as a whole, and on all other levels as well, through our analysis of advanced methods like Elliott Wave theory, Fibonacci Retracement, and much more.

In the previous two editions of our guide (Read Part I and Part II), we discussed how technical trading and charting have become invaluable tools in studying the behavior of various coins and predicting future movement to take proper trading steps in the cryptocurrency markets.

These incredible tools not only help to predict direction and momentum but also help in identifying the support & resistance for the coin.

What is The Elliott Wave Principle?

Remember we said ‘

Market moves in waves

In the previous edition, we also told you that the current price of the asset reflects everything about it.

The crypto market is driven by psychology, i.e. greed and fear called FOMO and FUD among crypto traders.

This psychology of the crypto market drives it in two directions - the direction of the trend and the counter-trend direction. This is what the Elliott wave theory proposes. Elliott said that the waves in the market are the direct result of the mass psychology of fear and greed of traders and investors.

The theory stated that mass psychology occurs in patterns and these patterns are recurring, happen on all timescales, and are fractal in nature. 

According to Elliott wave theory, there are two types of waves - Impulse/motive wave and correction wave. Basically, the impulse/motive waves are the ones in the direction of the trend while the correction wave is the counter-trend one.

The impulse/motive wave consists of five wave movements with three advancing waves of 1, 3, and 5 in the direction of the trend and two counter-trend waves i.e. 2 & 4, in the downward direction.

The corrective wave consists of three waves with two receding waves labeled A and C, with a counter wave (upward) labeled B, as shown in the chart below. 

The Elliott theory is the strict follower of, “What goes up must come down”, thus the theory dictates that the impulse waves must be followed by correction waves. We need to take into account three rules before using the Elliott wave theory:

Rule 1: When it comes to the impulse/motive wave, Wave 3 is never the smallest wave. In general, it is the largest wave in an impulse/motive phase of the market.

Rule 2: The starting point of Wave 4 is never lower than the endpoint of Wave 1 (the only exception is during the formation of a triangular pattern).

Rule 3: In the motive phase, Wave 2 is never allowed to go beyond the starting point of Wave 1.

Now let us test the Elliott Wave Theory to identify the best entry and exit point in the market! 

When To Enter A Trade According To Elliott Wave Principle?

Though the best entry point is ideally at the start of the first wave. Unfortunately, these waves are quite hard to spot as they come after a period of consolidation (these can sometimes last days or weeks) or after a sudden dip.

Therefore, most traders who refer to Elliott pattern, start at the bottom of the second or fourth wave as these are much easier to spot. 

A word of caution: NEVER buy near the top of the third or fifth wave!

Now talking about the best exits, well, the end of the third corrective wave is most favorable but again these can be tough to spot. Also, these final waves can retrace to 100% of the initial 5 Wave Elliott pattern.

Therefore, to have a safe exit you should look for a consolidation that breaks outside of the final corrective wave trend line. If you want to be a long time trader, try selling on the fifth wave.

How to Trade Cryptocurrencies Using Fibonacci Retracements?

A trader named W.D. Gann came up with the ultimate tool used to predict potential support and resistance levels for price action - Fibonacci Retracements! Gann observed many of his trades and found that the correction (retracements) waves found support around 50% of the length of the original impulse/motive wave.

He observed that if the price dropped below the 50% level, it often meant a full 100% reversal, else if the price stayed above the 50% level then it meant trend continuation. 

The Fibonacci Retracements are based on the Fibonacci number sequence. This sequence goes like 

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597… (repeats to infinity)

In the sequence, each successor is derived from the sum of the preceding two numbers. Fascinatingly, the ration between two consecutive numbers in the Fibonacci sequence is roughly 1.618 or 0.618 (inverse of 1.618) and is known as the “golden ratio,” or “phi”.

The amazing thing is that we often witness this ratio in nature, whether it is the arrangement of flower petals or galaxies or the human body. The examples of the Fibonacci sequence in nature are seemingly endless, as growth is a key part of nature and evolution.

It is the Fibonacci ratios that the traders and investors use while trading. 

Using The Fibonacci Retracements

The Fibonacci ratios are used in the Elliott theory as potential levels where impulse/motive waves and correction waves begin and end.

The most common levels are:

• 0.236
• 0.352
• 0.5
• 0.618
• 0.786

Well, 0.5 is not a Fibonacci ratio but it is often used and all these ratios are most commonly used to determine retracement levels.

But before we use the Fibonacci tool to identify potential support or resistance levels, we must first be able to identify a “swing high” and “swing low.”

A swing high is defined as a candlestick at the peak of a trend that has a lower high directly to its right and left, in any time frame. On the other hand, a swing low is the low candlestick stick of a trend with a higher low on each side. 

After identifying these points, connect a swing low to a swing high to generate the potential support levels which we commonly call retracements.

On the plotted graph, each retracement is derived from the vertical “trough to peak” distance divided by ratios in the Fibonacci sequence as shown in the graph below. 

The resistance levels are found in a similar manner, except that this time we need to be connecting the swing high to swing low. You can find the retracements by dividing the distance from peak to trough using ratios in the Fibonacci sequence.

To get the best profits out of Elliott theory and Fibonacci retracements tools make sure to use other indicators like moving averages or the relative strength index (RSI).

Now that we have discussed the Elliott theory and Fibonacci retracements, let us dive deeper into the crypto trading world to understand the anomalies in trading patterns. 

How to Profit from Chart Pattern Failures and Anomalous Patterns?

Trading patterns offer great insights into the crypto market and provide traders with amazing trading signals for entry, targets, and even stop placement identification.

But one can never be totally dependent on chart patterns, as these patterns may fail and cause a thrust in the opposite direction.

The chart patterns must always be used in complementary to our core strategy of supply and demand for avoiding losses. 

We say that a chart pattern failed when a specific chart pattern does not materialize as anticipated and is unable to achieve its potential, causing the price action to move in the opposite direction than expected.

This chart pattern failure can provide for a unique trading opportunity as the failure causes an influx of stop-loss orders to be triggered.

Let us look at an example to better understand chart pattern failures.

We have a double bottom chart pattern (marked in blue) with the neckline (marked in magenta) playing the role of a confirmation signal. The green circle points out how the price action breaks the neckline, confirming the bullish potential of the pattern.

Conversely, the price action returns and initiates a strong bearish move, failing the Double Bottom setup and thus trapping many traders on the wrong side of the market.

But why do chart patterns fail? Most of the time the chart patterns fail because we evaluate them before time since failed patterns are usually part of something bigger.

Often, you will witness that the failure pattern is evolving into another pattern, either on your trading timeframe or a higher degree timeframe. For example, if we look at the failed Double Bottom pattern above, we will notice that it eventually turned into an Expanding Triangle.

After the Double Bottom pattern gets confirmed, the price action returns and creates another bottom on the lower level of the Expanding Triangle.

This sheds light on information that the black horizontal support is of great importance in accessing future price development. It is after the breakout (marked by the red circle) that the triangle reaches its full potential. 

How to Trade Failed Chart Pattern Setups?

Before you trade a failed chart setup, you might experience a loss caused by the initial false breakout. This is normal and you should not panic about this loss and prepare to trade in the opposite direction to catch the real price move.

For entering a Failed Pattern trade, first, identify the point of failure in the pattern, you will notice a weak breakout and follow thru, then a swift return to the breakout point.

After the breakout, you will notice that the price action is beginning to return to the critical level of the pattern on stronger momentum compared to the momentum during the initial breakout.

This is a clear indication of a failed chart pattern setup. This is the best time to enter a failed pattern trade i.e. when the price action breaks and closes beyond the original breakout level, but in the opposite direction. 

The first thing you need to do in order to book profit when trading failed pattern charts is to observe if the price action is likely to evolve into a new chart pattern.

In case of a new chart pattern, simply follow the take profit rules of the newly created pattern to exit your trade, else, rely on your price action knowledge to carefully manage the exit.

If the cryptocurrency pair starts to stall, you should keep a lookout for reversal signs and continually monitor swing highs and lows for potential exit opportunities. 

Understanding Trading Failed Chart Formations with the Volume Indicator

Now let us talk about the ways to combine the Volume Indicator with chart pattern failures to achieve better accuracy in our trades.

There are two simple rules while trading with the Volume indicator which provides us with valuable indicators to confirm a pattern failure.

Rule 1: In case a breakout occurs on high or increasing trading volume, then the breakout is most likely authentic.

Rule 2: Else if a breakout occurs on low or decreasing volume, then the breakout is probably false.

The above chart pattern failure shows transitions into an opposite move, along with the Volume Indicator, which helps us to gauge market conditions better.

The given chart begins with a price consolidation, having the shape of a Symmetrical Triangle.

The Symmetrical Triangle pattern makes a clear breakout through the upper level with the volumes decreasing at this time. But after the price breaks the triangle upwards, it creates a top and reverses with the price moving below the original breakout point of the Symmetrical Triangle.

The Volume Indicator at this point shows the progressively decreasing volume, creating a nice opportunity for shorting the pair. 

After this, the price of the pair decreases, and the trend is relatively sharp compared to the previous price action and therefore it is easy to distinguish.

But after the bottom formations begin to slow down and consolidate, we witness another pattern i.e. a Falling Wedge, on the chart (marked with the yellow lines).

From the Volume Indicator chart, you can notice that volume is increasing at the time of the breakout through the upper level of the wedge.

This implies that the breakout is likely real and should have a good follow through.

Based on this assumption of a breakout, we should use this breakout to close our trade. 

Conclusion

Having all this knowledge is very important for a trader to protect themselves from entering a trade only to incur losses. You have to understand that knowing when not to take a trade is as important as knowing when to trade.

Trading in a volatile cryptocurrency market is a risky affair because nothing in trading is 100%, not even the tried and tested ways.

It is important that we study the chart patterns and indicators carefully but it is also important to know that Technical Indicators will fail and they fail often.

In order to succeed with your trading strategy, you need to learn how to properly manage the risk on each trade and trust your own trading experiences and the core strategy of supply and demand for avoiding losses.

(Disclaimer: All Information given above is intended for educational purposes only and shall not be taken as trading advice #DYOR(