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.
The theory behind Fibonacci is that this mathematical pattern can be used to predict the waves of a trend. The most critical 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&P 500; it stretches back five years to 2007. This enables us to get some perspective of the Financial Crisis in 2007 and compare that to what happened since.
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 significant Retracement levels are drawn (the Grey Dotted Lines)
Important Points to Note
In the 4.5 years since October 2007, the markets failed to reach an all-time high of 1,550.
In 2008 when the market broke down through 1,100 points, the market collapsed.
- 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 decline 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.
We can see that the 21.6% retracement line at circa 1,225 provided resistance. A strong move up through this area would be positive.
Fibonacci uses nature’s numbers to enable us to estimate potential areas for support and resistance in a stock’s chart pattern. Drawing from the bottom of an uptrend to the top of the uptrend helps you visualize where a stock may pull back to while still in its uptrend. Conversely, using the Fibonacci indicator at the top of a trend to the bottom of a trend can allow us to visualize to which price a stock might move upwards.
In this section, we looked at charts and learned how to draw trend-lines. Trend lines are a useful way to help us envisage support and resistance areas in a stock price. We then looked at chart patterns and what they mean. We looked at all the major chart patterns. Then we looked at gaps in stock prices, the types of gaps, and how to act on them.