Fibonacci retracements
Fibonacci retracements help anticipate support and resistance levels along with price targets.
Overview
After making long sustained moves in one direction, many markets retrace a part of the move before continuing on further. The Fibonacci indicator, popularized by Ralph Nelson Elliot, is used to try and forecast potential support levels and price targets, based on the height of the overall move and any wave patterns.
For example, if a stock increased from $5 to $10 and then slipped back 50%, this retracement would take it to $7.50 before it continued upwards again.
This indicator uses mathematical ratios discovered by Leonardo Fibonacci's in the 12th century. The Fibonacci summation series is 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144... and so on to infinity. Interestingly, these numbers have the following constant relationships:
The sum of any two consecutive numbers equals the next higher number.
The ratio between any number and the next higher number approaches 0.618 after the first four calculations.
The ratio between any number and the next lower number is approximately 1.618 (the inverse of 0.618).
The number 1.618 is commonly referred to as the Golden Mean or the Golden Section. The real value of this number series is that it is "the most important mathematical presentation of natural phenomena ever discovered" (R. Fischer). It keeps popping up in everything from the proportions of the Egyptian pyramids... the number of florets in flower heads... the double helix of the DNA molecule... to the logarithmic spiral of the nautilus shell.
(The well-known Elliot Wave Principle is also based on the application of Fibonacci numbers to the waves evident in any price chart.)
Fibonacci Retracements
Fibonacci Retracements are based on a trendline drawn between a significant trough and peak.
If the trend is rising, the retracement lines will descend from 100% to 0%
If the trendline is falling, the retracement lines will ascend from 0% to 100%
Horizontal lines are drawn at the common Fibonacci levels of 38%, 50%, & 62%
As the price retraces, support and resistance often occur at or near the Fibonacci Retracement levels.
Fibonacci Retracements
Once you have established your start and end points, horizontal retracement lines are then drawn. The lines are spaced from the price of the end point toward the start point at intervals of 23.6%, 38.2%, 50%, 61.8%, 100%, 161.8%, and 261.8% of the distance between the prices of the two points.
1. Fibonacci Retracements
Fibonacci retracements use horizontal lines to indicate areas of support or resistance. They are calculated by first locating the high and low of the chart. Then five lines are drawn: the first at 100% (the high on the chart), the second at 61.8%, the third at 50%, the fourth at 38.2%, and the last one at 0% (the low on the chart). After a significant price movement up or down, the new support and resistance levels are often at or near these lines. Take a look at the chart below, which illustrates some retracements:
Fibonacci Retracements also have several additional new options. A new checkbox entitled "Use Last __ Bars" give the user an "Auto-Retracement" capability. For instance, if the user check this option and chose a value of "50" bars on a 1-minute chart, then an automated trendline connecting the high and low of the past 50 1-minute bars would be used as the base trendline for all retracement levels. A checkbox entitled "extend" gives the user the option of extending his retracement lines to the right edge of the chart, or limiting the line to the range of the base trendline (between the Begin and End date/times). A "Show %" checkbox gives the user the option of showing the percent level in an annotation box on the left side of each retracement line. A "Show Price" checkbox gives the user the option of showing the price in an annotation box on the left side of each retracement line.
Retracements
Fibonacci Retracements are displayed by first drawing a trendline between two extreme points, for example, a trough and opposing peak. A series of nine horizontal lines are drawn intersecting the trendline at the Fibonacci levels of 0.0%, 23.6%, 38.2%, 50%, 61.8%, 100%, 161.8%, 261.8%, and 423.6%. (Some of the lines will probably not be visable because they will be off the scale.)
After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels.
In the following chart of Eastman Kodak, Fibonacci Retracement lines were drawn between a major trough and peak.