From The Free Forex Encyclopedia
Fibonacci ellipses identify underlying structure of price moves. Fibonacci ellipses circumvent price patterns. When a price pattern changes, the shape of the ellipse circumventing the respective market price pattern changes too. We can find long and short ellipses, fat and thin ellipses and ellipses that are flat or have a steep angle. There are very few market price moves that do not follow the pattern of a Fibonacci ellipse. In general, the shape of an ellipse is defined by the ratio of major axis to minor axis. Ellipse is turned into Fibonacci Ellipse where this ratio is a member of Fibonacci series.
The strength of Fibonacci ellipses is that no matter how many waves or sub waves we find in a price pattern, we receive a solid overall picture of the total price pattern as long as it can be circumvented by a Fibonacci ellipse. It starts in the beginning of a wave A in 3-wave patterns and its width is chosen so that the beginning and the end of a wave B is tied between extreme points of minor axis of the ellipse. As long as the price stay inside the ellipse it is very likely to reach level indicated by the end of major axis at approximate time it projects onto a time scale of a graph.
Fibonacci ellipses, also known as phi-ellipses, are a lesser-known member of the general category of Fibonacci studies in technical analysis. An important difference between Fibonacci ellipses and standard Fibonacci tools is that Fibonacci ellipses are are used to determine overall market trends, rather than merely levels of support and resistance.
A Fibonacci ellipse can be drawn when three points on a chart are known: an arbitrary starting point, the first peak before a reversal in price levels, and a second point representing a second reversal back toward the direction of the overall trend. Once these three points are known, an ellipse can be drawn inscribing all three. The line bisecting this ellipse along the median can be taken as an indicator of the median price level for the overall trend, and traders consider the point where the median line crosses the far boundary of the ellipse to be an indicator of an impending market reversal.
There are a number of additional complexities when working with Fibonacci ellipses. Once three Fibonacci ellipses in a row are drawn, on occasion a larger Fibonacci ellipse can be drawn circumscribing all three. If this happens, it should be considered an extremely strong indicator of an upcoming trend reversal. Additionally, the slope of a Fibonacci ellipse is usually taken to indicate the severity of the upcoming price reversal, allowing traders to take the appropriate positions.
Fibonacci ellipses can only be drawn by computer, limiting their utility if the trader doesn't own appropriate technical analysis software.