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Fun With Fibonacci
12th century monk Leonardo de Pisa, better known to his
friends as Fibonacci, discovered a fascinating mathematics
sequence that appears throughout nature. Beginning with a simple
1 + 1, the sum of the last two number sets that precede it
creates another Fibonacci value:
1+1=2 1+2=3 2+3=5 3+5=8 5+8=13 8+13=21 13+21=34 21+34=55 etc,
etc. |
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For reasons that remain unknown, major ratios drawn from these
numbers describe a predictable interaction between trend and
countertrend movement in markets. The most important ones to
remember are 38%, 50% and 62%. Applying these percentages to
trending price predicts the extent of retracement contrary to
the underlying trend, as well as how far a new high or low will
travel. For traders, these hidden points represent invisible
support/resistance zones where prices will hesitate and/or
reverse.
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| Fibonacci numbers closely relate to Elliott Wave theory.
However, using them requires only a short primer in that arcane
study. At the minimum, develop the basic understanding that
primary trends travel in 5 waves (3 forward and 2 backward)
while countertrends move in 3 waves (2 forward and 1 backward).
That's all you need to easily manipulate Fibonacci price grids.
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Grab some charts and a good charting program. All good technical
analysis software has this Fibonacci function. For example, both
SuperCharts and Real Tick allow custom entry of all major
points. Lay Fib lines over the extremes of dynamic trends using
the Fibonacci Grid. Or just take a calculator and measure swing
action from intraday, daily or weekly quote listings.
Placed correctly, you'll notice that most markets swing off
Fibonacci ratios as they move from support to resistance and
back. Once you get the knack of it, you'll see that trends in
all time frames have common elements and similar
proportionality.
Trade decisions using Fibonacci retracement must include
entry/exit analysis (risk:reward) with respect to key pivot
points. Focus on getting into a market at major ratios while
standing aside as price hovers between key zones. Most times,
the smartest execution will be counter the most immediate
short-term trend.
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| Hidden Support and
Resistance: Fibonacci defines trend movement over broad
time frames as well as very short ones. On this weekly
chart of CPQ, note how the 38%, 50% and 62% retracement
of the strong 1997 rally have defined the broad base
under construction for almost two years.
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| Retracement science works
in bear markets as well as bull markets. Major market
plunges frequently recover 50% or 62% of the last
selloff before continuing the decline. |
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