Fibonacci Market
Faustina Bartsch
In finance, Fibonacci retracement is a method of technical analysis for determining support and resistance levels.[1] It is named after the Fibonacci sequence of numbers,[1] whose ratios provide price levels to which markets tend to retrace a portion of a move, before a trend continues in the original direction.
A Fibonacci retracement forecast is created by taking two extreme points on a chart and dividing the vertical distance by Fibonacci ratios. 0% is considered to be the start of the retracement, while 100% is a complete reversal to the original price before the move. Horizontal lines are drawn in the chart for these price levels to provide support and resistance levels. Common levels are 23.6%, 38.2%, 50%, and 61.8%. The significance of such levels, however, could not be confirmed by examining the data.[2] Arthur Merrill in Filtered Waves determined there is no reliably standard retracement.[3]
Fibonacci retracement is a popular tool that technical traders use to help identify strategic places for transactions, stop losses or target prices to help traders get in at a good price. The main idea behind the tool is the support and resistance values for a currency pair trend at which the most important breaks or bounces can appear.[4] The retracement concept is used in many indicators such as Tirone levels, Gartley patterns, Elliott wave principle, and more. After a significant movement in price (be it up or down) the new support and resistance levels are often at these lines.
Unlike moving averages, Fibonacci retracement levels are static prices. This allows quick and simple identification and allows traders and investors to react when price levels are tested. Because these levels are inflection points, traders expect some type of price action, either a break or a rejection. The 61.8% (0.618) Fibonacci retracement that is often used by financial analysts corresponds to the golden ratio.[1]
Extensive backtests of Fibonacci retracement over thousands of stocks have shown that the retracements values of 38%, 50%, and 62% had been no likelier to appear than any other of the possible retracement values.[3][5]
Now, the expectation is that if AUD/USD retraces from the recent high, it will find support at one of those Fibonacci retracement levels because traders will be placing buy orders at these levels as the price pulls back.
The expectation for a downtrend is that if the price retraces from this low, it could possibly encounter resistance at one of the Fibonacci levels because traders who want to play the downtrend at better prices may be ready with sell orders there.
If enough market participants believe that a retracement will occur near a Fibonacci retracement level and are waiting to open a position when the price reaches that level, then all those pending orders could impact the market price.
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Casey Murphy has fanned his passion for finance through years of writing about active trading, technical analysis, market commentary, exchange-traded funds (ETFs), commodities, futures, options, and forex (FX).
A technical analyst looking for potential support and resistance levels will select two prominent points from a stock's chart, typically the highest and lowest points over a set period of time, and divide the vertical distance by key Fibonacci ratios. With the levels identified, horizontal lines are drawn, enabling market makers to identify trading opportunities.
The 38.2% ratio is found by dividing one number in the series by the number two places to the right. For example, 21 divided by 55 equals 0.382. The 23.6% ratio divides one number in the series by the number three places to the right. For example, 8 divided by 34 equals 0.235.
Fibonacci levels are mainly used to identify support and resistance levels. When a security is trending up or down, it usually pulls back slightly before continuing the trend. Often, it will retrace to a key Fibonacci retracement level such as 38.2% or 61.8%. These levels provide signals for traders to enter new positions in the direction of the original trend. In an uptrend, you might go long (buy) on a retracement down to a key support level. In a downtrend, you could look to go short (sell) when a security retraces up to its key resistance level. The tool works best when a security is trending up or down.
Fibonacci levels can be useful if a trader wants to buy a particular security but has missed out on a recent uptrend. In this situation, you could wait for a pullback. By plotting Fibonacci ratios such as 61.8%, 38.2% and 23.6% on a chart, traders may identify possible retracement levels and enter potential trading positions.
As with all technical analysis tools, Fibonacci retracement levels are most effective when used within a broader strategy. Using a combination of several indicators offers a chance to more accurately identify market trends, increasing the potential for profit. As a general rule, the more confirming factors, the stronger the trade signal.
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The golden ratio is a mathematical concept that describes the relationship between two quantities where the ratio of the smaller quantity to the larger one is the same as the ratio of the larger to the sum of both. The golden ratio is approximately equal to 1.6180339887 and is denoted by the Greek letter phi (φ). The golden ratio has been observed in a variety of natural and man-made structures and is considered a universal principle of beauty and harmony.
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So basically the sum of any two adjacent numbers in the sequence forms the next higher number in the sequence: 1 plus 1 equals 2, 1 plus 2 equals 3, 2 plus 3 equals 5, 3 plus 5 equals 8, and so on to infinity.
Why is this important? Well after the first several numbers in the sequence, the ratio of any number to the next one higher is approximately .618 to 1 and to the next lower number approximately 1.618 to 1. The further along the sequence, the closer the ratio approaches 0.618 (or 61.8%). Between alternate numbers in the sequence, the ratio is approximately .382, whose inverse is 2.618.
Here is an example of 30-year U.S. Treasury Bond Futures during 2011-2012. After putting in a low in February 2011, prices rallied in a nice uptrend into the Fall of that year. The correction from those highs ended by finding support near the 38.2% retracement of that prior rally. Support came into play and the rally resumed into the following year:
The same can be seen to the downside during downtrends. Here we are looking at the Euro vs the U.S. Dollar $EURUSD in 2012. This market put in its low in early 2012 and went on to rally for a couple of months. All of this was within an ongoing downtrend. Once prices in May took out those former lows near 1.26, the next logical target was the 161.8% extension of the prior rally. This gave us a target just under 1.21 which is precisely where $EURUSD found its bottom that Summer and then went on to rally and make new highs:
Here is a good example of a very strong market that just kept rallying relentlessly. We are looking at one of the leadership groups off the 2009 lows: Consumer Discretionaries $XLY. You can see the high in 2007 and low in 2009, very similar to the S&P500 and other markets. As prices of this sector ETF reached the 261.8% extension of that 2007-2009 correction, the exhaustion became evident. This sector did nothing but go down since reaching that price objective:
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