Fibonacci techniques for profitable trading
Fibonacci analysis can boost your market’s performance, but you will need to master a few tricks of the trade to get the most out of this mathematical sequence that was discovered in the Western world over 800 years ago. Let’s tackle the subject with a quick Fibonacci alphabet, then get to work with two original strategies that directly harness its hidden power.
Key points to remember
- Fibonacci analysis uses the work of the 12th-century Italian mathematician Leonardo de Pisa (also known as Fibonacci) to use a logical sequence of numbers to predict stock trends and price action.
- The Fibonacci Flush strategy identifies hidden support and resistance levels that an investor can use for entry, exit and stop placement.
- The Parabola Pop strategy tracks breakouts above and below retracement levels to provide early entry points for major breakouts and breakdowns.
What is a Fibonacci analysis?
The 12th-century monk and mathematician Leonardo de Pisa (later called Fibonacci) discovered a logical sequence of numbers that appears throughout nature and in great works of art. Unknown to the great monk, these Fibonacci numbers fit perfectly into our modern financial markets because they describe – with great precision – the complex relationships between individual waves within trends, as well as how far the markets will retreat when they are will revert to previously negotiated levels.
Starting with 1 + 1, the Fibonacci sequence, whose first number is 1, is made up of numbers that are the sum of themselves and the number that precedes them. Therefore, 1 + 1 = 2, 1 + 2 = 3, 2 + 3 = 5, 3 + 5 = 8, 5 + 8 = 13, 8 + 13 = 21, 13 + 21 = 34 and 21 + 34 = 55 , which indicates that 1, 2, 3, 5, 8, 13, 21, 34 and 55 are all Fibonacci numbers. Subdividing these digital strings reveals repeated ratios that have become the basis of Fibonacci grid analysis in swing trading and other market disciplines.
The .386, .50, and .618 retracement levels form the basic structure of Fibonacci grids found in popular market software packages, with .214 and .786 levels coming into play during times of higher volatility. The initial analysis technique is simple enough to be understood and mastered by market players at all levels. Simply place the grid on the end points of a major high and low in an uptrend or downtrend and look for close alignment with major price changes.
Upward and downward trends
More in-depth market analysis requires more effort as trends are harmonic phenomena, which means they can break down into smaller and larger waves that show an independent price direction. For example, a series of relative bullish and bearish trends will fit into a one or two year uptrend in the S&P 500 or the Dow Jones Industrials. We see this complexity more clearly when we go higher from daily charts to weekly charts, or lower from daily charts to 60 or 15 minute charts.
The Fibonacci Flush Strategy
A single Fibonacci grid on a daily chart will improve results, but ratios get sharper when looking at two or more time periods. Swing traders taking the next step will find great value in the daily and 60 minute charts, while market timers will benefit when they step back and combine the daily and weekly charts. In either case, alignment between key Fib levels in different time periods identifies hidden support and resistance that can be used for entry, exit, and stop placement.
For example, in the chart above, you will see that Microsoft Corporation (MSFT) shares hit a deep low at $ 42.10 in October 2014 and rallied in a vertical wave that ended at 50, $ 05 a few weeks later. The subsequent pullback settled on the 38.2% retracement (.382) for four sessions and collapsed into a gap in mid-December that landed the price on the Fibonacci retracement at 61. , 8% (.618). This level marks a tradable low before a strong rally that stops at the 78.6% retracement (0.786).
Notice how other graphing features interact with key Fibonacci levels. Selling at the 62% level also bridges the October gap (red circle), while the subsequent rebound stops near the three November highs (blue line) aligned with the 78.6% retracement. This tells us that Fibonacci analysis works most effectively when combined with other technical forces at play, such as spreads, moving averages, and easily observable highs and lows.
Support and resistance
Now let’s zoom in and identify a Fibonacci technique that you can use to find low risk entries missed by less attentive market participants. The price drop relies on the 38% retracement for four sessions, sucking up a supply of capital looking for a reversal. The downside spread traps this crowd, which is shaken as the stock posts a volatile low at 62%. While it makes sense to buy at this support level, it is a risky strategy as the spread could easily kill the upside and force another outage.
Then comes the important part. Rise above 38% retracement restores support, triggering Fibonacci Flush buy signal, predicting that positions taken near $ 47 will produce a reliable profit. At the same time, upset shareholders are reluctant to buy back at this price because, as the saying goes, “once bitten, twice shy”. This reduces interest in the trade while still allowing fresh money to carry risk in a low volatility trade, and building on a long observed trend for support to hold after being tested, broken, then reassembled.
The Parabola Pop strategy
Referring to the chart above as an example, the 78.6% retracement level stands guard as the final harmonic barrier before an instrument completes a 100% price swing (higher or higher). lower). This is valuable information because it tells us that a break above this level in an uptrend, or a break in a downtrend, will extend to the last swing high or low as the minimum target. Doing the math suggests a free spin for the last 21.6% of the rally or wind-up wave.
This Parabola Pop strategy works very well over longer periods of time and can even provide early entry to major breakouts and breakdowns on widespread issues. As an example, look at Facebook, Inc. (FB) after peaking at $ 72.59 in March 2014 and entering a correction that found support in the mid-1950s. The rebound that followed hit the retracement of 78.6% to $ 68.75 two months later and stopped, giving almost three weeks of side action.
The stock rallied above harmonic resistance on July 21 (red line) and took off, completing the last 21.4% of the 100% price change in just four sessions. In addition, the fourth day saw a breakout above the March high, triggering a new round of buy signals that gave Fibonacci-focused shareholders plenty of profitable options including let it rise, take partial profits or risk the balance on the new uptrend.
Facebook’s breakthrough highlights a second benefit of the Parabola Pop strategy. Markets tend to hit these 100% levels as if a magnet is pulling price action. This parabolic tendency can produce exceptional results over very short periods of time. Of course, this is not a given because anything can happen at any time in our modern markets, but even a slight tilt towards the vertical marks a definable advantage over the competition.
The 78.6% to 100% surge marks a fractal trend that shows up in all time frames, from 15 minute charts to monthly charts, and can be traded effectively whether you are a scalper or a market timer. However, intraday holding periods are more likely to face trade-killing whipsaws and shakeouts, while the expected rally or sell size is often too small to record a reliable profit, especially after the negative impact of transaction costs.
The bottom line
Observing market trends through the lenses of a Fibonacci grid allows investors to see broader patterns beyond the immediate ups and downs and identify earnings prospects that may be just beyond that. from the sight of investors who are frightened by a short-term view of trends.
Used well, Fibonacci analysis tools give an investor the confidence and knowledge to weather the upheavals brought on by drastic downturns and to take advantage of opportunities to capitalize on the vertical change approach. However, it requires a willingness to resist the bewildering volatility that exists in compressed periods of time to see the market moves that a Fibonacci believer anticipates, based on mathematical formulas that have stood the test of time.