Fibonacci Retracement Indicator Made Simple

There are many ardent investors who follower the Fibonacci principles almost religiously across the globe.  Indeed, when you take a close look at the application of these scientific observations you may be compelled to take it seriously.

For this analysis example, we will use Fibonacci Retracement and apply it to the 2007 to 2008 Financial Crisis.  In fact, we will take a look at the charts a few years later in 2011.

What are Fibonacci Numbers In the Stock Market?

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.

Applying Fibonacci on a Chart

This is a long-term weekly chart of the S&P500, it stretches back 5 years to 2007 from 2011.  This enables us to get some perspective of the Financial Crisis in 2007, and compare that to what happened later.

SP-500 Market Technical Analysis Fibonacci Retracement September 2011
SP-500 Market Technical Analysis Fibonacci Retracement September 2011

Chart Courtesy of Worden Brothers Inc.

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

  • 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

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

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

The Market Moves Down

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

The Market Moves Up

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 2011 Battle Line

There was a battle occurring in the stock market in late 2011.  The market participants did not know which way the market will go.  The battle lines were 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)

stock-market-volatility
stock market 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.

Ultimately we know now that the market broke upwards and went on a huge bull run, recovering all the losses of the financial crisis.

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