Using Fibonacci Retracement to Draw the Battle Lines in the Stock Market

Dear Liberated Stock Traders,

Wall Street is very busy telling us that the “U.S Markets have been up 4 days in a row”.  Is that supposed to get us excited?  Before you leap on board with you hard earned money, we can have a look at the chart using Fibonacci Retracement to help us assess where some natural support and resistance levels are in the market.

For this analysis we will use Fibonacci Retracement.

Fibonacci numbers are revered in mathematics as the numbers that describe the natural world. The Sequence is simply the sum of any two numbers equals the next in the sequence
1,1,2,3,5,8,13,21,34,55,89 etc…..
1+1=2
1+2=3
2+3=5

The theory behind Fibonacci is that this mathematical pattern can be used to predict the waves of a trend. The most important numbers seem to be in percentage terms 38, 50, 62.

Therefore, if a trend moves from $1 to 100$, it may retrace (go back down) to 1 of 3 important levels. $62, $50, $38.

Fibonacci Retracement On A Long Term Chart

This is a weekly chart of the S&P500, it stretches back 5 years to 2007.  This enables us to get some perspective of the Financial Crisis in 2007, and compare that to what is happening today.

Chart Courtesy of Worden Brothers Inc.

You can use Fibonacci Retracement on any chart by following these instruction.

  • Select the Fibonacci Retracement Tool in your charting package
  • Select the Lowest Point on the chart in this case Point 1
  • Drag your mouse to the highest point on the chart in the future, in this case Point 2

You should then see the important Retracement levels drawn (the Grey Dotted Lines)

Important Points to Note

In the 4.5 years since October 2007, the market has failed reach the the all time high of 1,550.

In 2008 when the market broke down through 1,100 points, the market collapsed.

The Downside

  • The retracement line at 38.2%, is equal to 1,125 points in the index.  This is currently a support line.
  • Any drop through this area could see a further drop to 1,000 points, the 50% retracement line
  • The next drop zone could be 950 points, the 61.8% retracement line.  This maps back to 2009 /2009 perfectly.

The Upside

We can see that the 21.6% retracement line at circa 1,225 is providing resistance. A strong move up through this area would be positive.

The Battle Lines

There is a battle occurring in the stock market at the moment.  The market participants do not know which way the market will go.  The battle lines are drawn at 1,225 and 1,125.  We can see there is a battle due to the volatility.  In the daily chart we can the length of the candles in June 2011 was very small (low volatility).  Since the end of July when the index dropped through its 200 day moving average the size of the bars are much longer (high volatility)

Chart Courtesy of Worden Brothers Inc.

The volatility might be good for day traders who want to take risks.  But, for you and I it is better to wait until the market breaks out through the battle lines.  Then we should know which way the market will go.

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