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So you ask, "What does this have to do with my trading?" Well, price action in the markets also grows and contracts in accordance with the Golden Ratio. Fibonacci relationships apply to both price and time, but for now I will keep this simple and concentrate on the price aspect of it. The three main fibonacci ratios that we are concerned about are the .618, .500 and .382 ratios. For the sake of simplicity, .618 is rounded off to .62, and .382 is rounded off to .38. So we have the 62%, 50% and 38% levels. The 38% level is simply 1 minus 62% or 1-.618=.382 We can use these three ratios to help us establish projected percentage retracements of price action. A retracement is merely a "correction" in a bull run and is called a "rally" in a bear run. So lets look at very simple example. Let's say that stock "xyz" has formed a bottom at $50, turns around and heads up again and tops out at $54. We can expect a retracement of some magnitude, how much is not clear yet, and we would expect this stock to drop and bounce at one of the three retracement levels of 62%, 50% or 38%. To calculate the price levels, you simply take the high price minus the low price, multiply the difference by the retracement levels and add or subtract the results to or from the price from which it bounced. This sounds confusing, but its really pretty easy to determine with a little practice. So in our example here we have 54-50=4. The 38% level would be: 54-(.38x4), giving us 52.48. The 50% level would be 54-(.50x4)=52 and the 62% level would be 54-(.62x4)=51.52. Fortunately, most of us don't have to manually calculate this by hand each time. Most of the better charting software packages have a fibonacci tool, that will automatically draw the retracement levels on your chart once you have selected the high and low points. If you are a Real Tick user, you can left click on the little pencil push button located on your tool bar. It will bring up a small box. Scroll down and select "fibonacci". Move your cursor out of the box onto the chart, and you will notice your cursor now turns into a little pencil. To draw the retracement levels on your chart, move the cursor to the high of the move, left click, hold, and drag it down to the low of the move and release the mouse buttom. Now you will see a bunch of lines. There is a line at the high and low and then three lines inbetween these. These are the 62%, 50% and 38% fibonacci retracement levels. These are our primary concern. You should also see two more lines outside of the ones at the high and low, but we will keep this simple for now and not discuss those. They are used for price expansion projections, not retracements. Now, as I have stated before, as with anything in trading, including any technical indicator, which is what fibonacci retracement levels are, there are no guarantees and there is no Holy Grail. Just because you have established the retracement levels on your chart does not guarantee that the stock will indeed bounce there. You should use these in context of the overall trend of the particular stock.....in other words......if I am long biased on a stock because of my daily chart analysis or something else, I will use fibonacci to help me pinpoint an entry on which to go long. I would not use it to short the stock. So in the example above, I would not be looking to short the stock at a fib level between where it bounced and the high at $54.......there are exceptions of course.......but this is a general rule. This should be more clear to you in the chart examples I will give. The 50% level is the strongest and most significant of all the levels, Many stocks will retrace almost exactly to this level and bounce. Another important thing to remember, many times the price will have good momentum and will overshoot the fib somewhat and go back to it and hang there for a short while before taking off again. The fib kind of acts like a magnet attracting a piece of steel. It says, "Come back to Mama!" |