Fibonacci retracements, fans, arcs, and time series are some of the best technical analysis tools for traders. They are not perfect indicators (what is right) but they are incredibly helpful if you understand the basics.
Many years ago an Italian gentleman named Leonardo Fibonacci discovered ratios that exist throughout all of nature. These ratios are used to describe the proportions found in atoms as well as patterns found among stars and planets. The proportions help to keep balance in the natural world, and it also appears that stock markets exhibit a similar proportion.
Bees Can Teach Us About Trading
One example of this ratio is found in bees. If you count the number of female and male bees in any particular hive then divide the number of females by the number of males, you will find the number to be something close to 1.618. Another example that’s easier to measure is the human body. For this, you will first measure the distance from the shoulder to the fingertip. Next, measure the length from the elbow to the fingertip. Divide the larger number by the smaller number. The result? You get a number in the region of 1.618.
This quotient (1.618) is referred by many times as the golden mean, the golden ratio, or the divine proportion. Nearly everything in nature contains measurable properties that conform to this ratio. What’s more? Even financial markets follow this same pattern.
How Does This Relate To Trading?
In the world of stock analyzing, the golden ratio is normally expressed in three different percentages – 61.8%, 50%, and 38.2%. When applying the Fibonacci ratios to stock trading, there are four main methods used: fans, arcs, retracements, and time series.
Fibonacci Fans, just as the name suggests, are made from diagonal lines. They comprise three diagonal lines that use Fibonacci ratios to help identify key levels of support and resistance. To create Fans, the high price and the low price in a given period are first determined. Thereafter, a vertical line is drawn through the point furthest to the right. This line is then divided to show the key Fibonacci ratios of 61.8%, 50%, and 38.2%. From the point furthest to the left, three lines are drawn to the new percentage markers.
In addition to being used to construct support and resistance trendlines, Fibonacci Fans also help to measure the speed of a trends movement. For example, if prices move below a Fibonacci Fan trendline, it is highly likely that the price will fall even further until it reaches the next Fibonacci Fan trendline. On the same note, if prices rise above a Fibonacci Fan trendline, then that trendline is likely to act as resistance.
In a nutshell, Fibonacci Fans can help predict areas of time in which prices might change direction.
A Fibonacci Arc is a charting technique consisting of three curved lines that are drawn to predict key support, resistance levels, and reversal zones of counter-trend bounce. Once again, the peak and the trough for the Base Line are first identified. From the desired point, lines resembling mathematical compass curves are drawn to represent 61.8%, 50% and 38.2% distance from the point. The radius of the first Fibonacci Arc is equivalent to 38.2 percent of the Base Line. For the second Fibonacci Arc, the radius is in the middle of the Base Line at 50 percent. Finally, the third Arc has a radius measuring 61.8 percent of the Base Line.
Like all other annotation tools, Fibonacci Arcs rarely work effectively as standalone systems. In fact, it’s not advisable to rely on them fully since they’re hardly perfect. For better results, you need to use other related tools to help you confirm support, resistance, and reversals.
Fibonacci retracements are hugely popular tools used by many traders to help identify strategic places in which to place transactions, target prices, and even stop losses. Additionally, these horizontal lines can also be used to show the points of resistance or support. After identifying the high and low prices on the chart, five lines are marked. The first line will be at 100% or the high point. The second line appears at 61.8%. The third line appears at 50%. The fourth line appears at 38.2%. The fifth and final line will be at 0% which is also the low point. Whenever a noticeable price fluctuation occurs, the new support and resistance areas will be within these lines.
Fibonacci retracements levels are characterized by prices that do not change. This static nature of prices means that traders and investors can count on these tools to anticipate and react wisely once price levels are tested.
Traders can also use Fibonacci retracements to help identify the end of a correction or a counter-trend bounce. For better results, however, it’s important to use additional signals such as candlesticks, volume patterns, or momentum indicators to confirm reversals.
This method is quite different from the three described above due to the use of vertical lines drawn in series. Typically, Fibonacci Time Series act as indicators that technical traders can use to predict periods in which the price of particular assets are likely to experience a substantial movement. This charting technique entails a series of vertical lines that correspond to a particular sequence of numbers popularly known as the Fibonacci numbers. Each successive number in this sequence equals to the sum of the two previous numbers. For reasons that are still unclear, these numbers help to determine the relative regions in which the prices of financial assets are more likely to experience significant moves in prices or change courses.
History has a way of repeating itself, which is the foundation of stock analysis. The Fibonacci ratio and its application to stock markets is a wonderful tool in identifying the support and resistance for stock prices.
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