**Every stock market technician monitors this
basic premise. You can count on each Market Maker understanding this
and applying it to their buy and sell decision making. Understanding
what the Market Makers are thinking can only help you become a better
a trader.
Overview
Fibonacci numbers are the result of work by Leonardo Fibonacci in
the early 1200's while studying the Great Pyramid of Gizeh. The fibonacci
series is a numerical sequence comprised of adding the previous numbers
together, i.e.,
(1,2,3,5,8,13,21,34,55,89,144,233 etc..)
An interesting property of these numbers is that as
the series proceeds, any given number is 1.618 times the preceding
number and 0.618% of the next number.
(34/55 = 55/89 = 144/233 =0.618) (55/34 =89/55 =233/144
=1.618), and 1.618 =1/0.618.
This properties of the fibonacci series occur throughout
nature, science and math and is the number 0.618 is often referred
to as the "golden ratio" as it is the root of the following
polynomial x^2+x-1=0 which can be rearranged to x= 1/(1+x).
So that's were the fib # 0.618 comes from. The other
fibs 0.382 and 0.5 commonly used in technical analysis have a less
impressive background but are just as powerful in Technical analysis.
0.382=(1-.618)=(0.618*0.618)
and 0.5 is the mean of the two numbers.
Other neat fib facts (0.618*(1+0.618)=1 and (0.382*(1+.618))=0.618.
Use of Fibonacci #'s in Technical Analysis
Fibonacci numbers are commonly used in Technical Analysis to determine
potential support, resistance, and price objectives. 38.2% retracements
usually imply that the prior trend will continue, 61.8% retracements
imply a new trend is establishing itself. A 50% retracement implies
indecision. 38.2% retracements are considered nautral retracements
in a healthy trend.
ABC's
Price objectives for a natural retracement (38.2%) can be determined
by adding (or subtracting in a downtrend) the magnitude of the previous
trend to the 38.2% retracement. After the 38.2% retracement the stock
should break through the previous swing point(B) on heavier volume.
If the volume isn't there the magnitude of the move will usually be
diminished, especially on very low volume.
A-B =C-D when B-C =38.2% of A-B
61.8% retracements are warning signs of a potential trend changes.
Confluence
Confluence occurs when you take fibonacci projections off of multiple
trends and get the same number and strengthens when it corresponds
with other technical advents such as gaps, swing high/lows, chart
indicators crossovers (MACD, RSI, Stochastics, etc.), trading congestion,
etc. The more confluence, the more significant the level. I really
take notice when I get two or more fib #s (say a 38.2% and 61.8%)
to correspond with a gap in the chart or a swing high. Confluence
is very powerful as it combines multiple technical analysis techniques
to arrive at the same conclusion, and should be relied on accordingly
IMHO
Potential Trading Strageties
Once a new swing point is established in an equity, a new
set of fibonacci numbers should be calculated, and confluence checked
to determine potential support/resistance levels and trading strategies.
For instance:
-If a stock is trending up, one may watch it until it
forms a top then calculate the fib #’s. If it retraces 38.2%
and turns with confluence, one could buy with an automatic stop under
the 50% retracement and objective of the ABC. The Risk/Reward ratio
for that trade is 0.118. (If you got stopped out 8 times and hit once
you would have a 5.6% profit).
-If the stock is trending down, you could bite at the
38.2% bounce with a stop at the 50% and get the same risk/reward ratio.
With both strategies it is critical for the volume to be heavier on
the swing point breakout.
-If a position is going with you and you're looking
for an exit point, calculate the 38.2% fib once a top is clear and
put a stop below it. It will not get you out at the top but you may
not miss that monster rally either.
