Technical analysis of fanlines is not very common. But it does have its uses as a method of technical analysis and works with Elliott Wave Theory. Fanlines are a simple pattern, and while there are different types, we are using them based on Fibonacci principles. The basic construction of fanlines is easy to master, but usually not necessary as most charting software will plot the fan for you. Howevever it is important to understand how they work.
Constructing Fanlines
First, we find the origin and the significant high point we want to use. Then we draw an imaginary line between the two points and use that as the hypotenuse of a right triangle. The opposite side of the triangle from the origin is the vertical size of the move, regardless of time. This is where we plot the Fibonacci values:
The three red lines represent the Fibonacci values of 38.2%, 50% and 61.8%. Yes, we know 50% isn’t actually a Fibonacci value, but securities show a strong tendancy to retrace to the 50% level at times so it is generally used as an additional value. Now we draw lines from the origin (the beginning of wave 1) to each of the Fibonacci marks and beyond:
Fanlines and Technical Analysis
Technical analysis of the fanlines on the Elliot wave is a tool for marking support and target values. The lines show the 38.2%, 50% and 61.8% retracements or corrections of the vertical move. The correction from the chosen significant high (point 3) saw the 38.2% fanline attracting initially. Notice how wave 4 stops right about where the 38.2% fanline is plotted. So if we wanted to be brave, we could have taken a short position after the turning of wave 3 to profit on the drop of wave 4. Technical analysis of the fanlines indicates where the correction will possibly move.
The security price turns back with the trend and climbs. Once it turns after wave 5, we see the price form the abc correction with the a turn again right about at the 38.2% line. And after the point b turn, we see the price correction move all the way to the 61.8% line before reversing and turning back to the original uptrend. How amazing is that? Granted, it doesn’t always work out this way, which is why we always need to confirm any technical analysis by looking at many indicators.
If the price would have broken significantly below the 61.2% fanline, we could probably determine that the general uptrend has ended and we are now in a downtrend rather than a correction.
Keep in mind this is a simplification of fanlines and further study is needed to fully understand fanlines and their place in technical analysis.
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