Fibonacci Numbers
Overview
Use in Trading
ABC's
Confluence
Trading Strategies
Links (Elliot Wave Tutorials)
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 with
or without a knowledge of Elliot wave 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. For a more detailed explanation of Fibonacci price
projections and price wave theory I highly recommend the
Elliot Wave Principle links below.
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
Trading Strageties JMHO
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. (let the
Fibonacci Calculator do most of the work for you). For
instance:
If a stock is trending up, one may watch it until it
forms a top then calculate the fibs. If she retraces
38.2% and turns with confluence, one could bite 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 she's 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. Won't get you out at the
top but you may not miss that monster rally either.
Think a stock is a dog but it's trading at it's high
wait for a 61.8% retracement from the last trend and
sell it, with the stop below the 50% retracement.
Post your favorite fib strategies or give feedback
Links
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