Charting University » Fibonacci Retracements
Fibonacci Retracements, pronounced (Fib-ah-nah-chee), are lines that show probabilities of upward and downward moves in price. The Fibonacci sequences can be especially useful for swing traders to identify reversals in trends and are one of the most powerful (and under used) tools available to traders. These measurements can be of great use with any stock or market that is reasonably liquid.
Who was Fibonacci?
Leonardo of Pisa (Pisa is a city in Tuscany, central Italy), was known as Fibonacci (1170 - 1250 A.D.). Fibonacci's 1202 book Liber Abaci introduced the Fibonacci sequence to Western European mathematics. Although he was born in Italy, he was educated in North Africa where his father, Guilielmo, held a diplomatic post.
The Fibonacci sequence is said to project stock market retracements, populations of bees and rabbits, the number of branches on a tree, how long it takes a spider to climb a wall, and has recently even been linked to human DNA double helix structures! It is truly an amazing formula.
What does it all mean to us in trading?
It is the ratio of the Fibonacci sequence that is important and valuable to us as traders, not the actual numbers in the sequence. These ratios to each other give us important values that traders use; 61.8%, *50% and 38.2%. The *50% is not really a Fibonacci level, but so many traders use it that it has a high tendency to reverse a trend after half of the previous move. It is for this reason that we add it to the Fibonacci lines.
To identify Fibonacci Retracement Levels, you must first identify the latest peak and valley in the stock or index. Once this is done, you can measure the 61.8%, 50% and 38.2% distances from valley to peak (or vice-versa if you are looking at a short position). Most good charting software includes a tool to help you calculate these levels.
The pioneering work of traders like W.D. Gann (1878 - 1955) and R.N Elliott (1871 - 1948) also showed that these ratios are prevalent in the financial markets. Although their works are extremely technical, they have been pr oven to be successful over many years of trading.
Fibonacci Retracements
This chart shows a graphical representation of the reversal points for stocks in an uptrend. The pattern would be reversed for stocks that are in downtrends. These drawings are offered on almost every updated charting program and allow for graphic support levels to be placed on a chart.
AAPL shows in the chart below that Fibonacci Levels do not always hold. I consider any drop back below the 50% line as a sign of severe weakness, and not a stock that I want to own at the time.
There chart below shows a beautiful "Cup & Handle" formation that broke long above $160.00. You should note that both the 50% retracement and the Handle of the Cup were both lined up at the same breakout line. We worked this chart night after night in the 'Stock Chart Report' until it finally provided the upward breakout we were watching for.
The interesting view of this chart is how different techniques can work so well together. The Cup & Handle is classic Western charting, the Shooting Star that started the Handle is from Japanese Candlestick charting of 300+ years ago, and the 800+ year old science of Fibonacci. These are all tools that work independently and when used together provide higher rates of success.
The chart below of BIDU is a good example of how stair-step support areas can be useful on a bounce and move upward. Note the holds at the 25%, 50%, 61.8% and 1.00 levels. The eventual push above the 1.00 level ($330.42) would be a common double top breakout, based on how I have this chart set-up.
Like all other technical indicators, there is no one Holy Grail. If there was, wouldn't everyone be using it? Every indicator needs a secondary confirmation or more to be successful. Consider learning more about and adding Fibonacci retracements to your arsenal of tools.