Fibonacci analysis can be complex, including concepts such as retracements, arcs, fans and other variations that can be applied to any price chart. I will offer a brief introduction to Fibonacci number sequences and ratios, and apply the concepts of arcs and fans to both longer-term and shorter-term trading using examples in the gold, Treasury bond and E-mini S&P 500 futures markets. Fibonacci analysis can be a valuable tool for traders, and worth exploring further.
There is a lot of relevance in this type of analysis for both swing-traders and day-traders, particularly when markets are moving sideways or in a consolidation pattern. I recommend using these techniques in conjunction with other technical indicators to both compliment and confirm your trading signals.
While he didn’t discover what’s known as the Fibonacci number sequence, Italian mathematician Leonardo of Pisa (also known as Leonardo Fibonacci) popularized their application in his book Liber Abaci, published in the early 13th Century. The numbers were used to explain natural phenomenon, primarily the population growth of rabbits within a small closed system. His concepts have relevance in many other areas today, including markets. Ralph Nelson Elliott built upon these concepts in what’s known as Elliott Wave analysis.
In the Fibonacci sequence, each number is the sum of the previous two numbers, starting with 0 and 1. So the sequence would be 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, etc. These numbers posses certain interrelationships to each other. The higher up in the sequence, the closer two consecutive Fibonacci numbers of the sequence divided by each other will approach the “golden ratio” (approximately 1:1.618 or 0.618:1). The golden ratio of 1.618 can be found throughout proportions in nature, in everything from bee hives to sunflowers.
When applied to markets, the golden ratio is typically translated into percentages: 38.2 percent, 50 percent, 61.8 percent and 100 percent. (I will round fractional numbers in my examples for simplicity.) These are retracements that can help you find support and resistance levels, as well market trends and timing reversals. They are particularly useful in sideways trading or range-bound markets, although that doesn’t mean the market has to be flat; it can trend up or down within a significant swing high or low. Retracements and arcs are useful within those parameters.
Both swing traders and shorter-term breakout traders can use Fibonacci levels to define and describe “wave” patterns. However, swing traders tend to use them to forecast price targets and swing points, whereas breakout traders will look for price action through technical patterns or key price levels to confirm and signal the breakout trade.
Fibonacci Retracements: Gold
Let’s look at a practical application of these concepts. The daily chart of April gold futures through early February showed two major bull and bear trends. For a longer-term (swing) trade, we’d be looking for a swing high at the top and swing low toward the bottom. Drawing the retracement lines from the bottom to top at 0, 38, 50, 62 and 100 percent, we can see the price levels that correspond to these ratios, and our support and resistance. A retest and failure of these levels indicates a momentum shift is likely. Look at the center of the gold chart around mid-November. You can see an upside breakout above the 38 percent retracement from late November into December (see the large green stretched candle in the middle and the horizontal line drawn near $810 an ounce). To confirm the breakout is the start of a new leg up, we’d need to see two or three strong closes above the 38 percent level. That didn’t occur—the rally failed and the market broke lower.
To create a buy signal, traders would want to see a confirmation of the move with two or three closes above the retracement level. When that happened, the market was able to move above the 50 percent level, and 62 percent level. The full 100 retracement of the move would project an upside target above $1,000; we saw the market eclipse that level on February 20, 2009. Keep in mind that the prices projected by the retracements are not exact numbers you would necessarily use to enter and exit trades, but important areas to be aware of.
Fibonacci Retracements and Arcs: Bonds
The daily chart of March Treasury bond futures also shows a strong bull and bear move, and provides a great application for our retracements. Looking at price action in February 2009 (to the far right of the chart), we would be looking for two to three closes below the 50 percent level to signal a possible downside breakout of the range. The market didn’t provide that confirmation, and indicated a possible move back to 130 on the upside, suggested by the 62 percent retracement level.
You can use Fibonacci analysis not just for price targets, but for timing as well. The arcs in the chart below demonstrate that, with zero at the top and a trendline drawn down to our 38, 50, and 62 percent levels. You can see how breaking through these points on the arc corresponds to possible timing for the next projected move, reflected in an extension of the trendline.
Fibonacci and Short-Term Trading: E-Mini S&P
Fibonacci analysis is not only useful for longer-term swing traders, but also for shorter-term traders looking for intraday opportunities. Looking at a 15-minute chart of the March E-mini S&P on February 17, 2009, we saw a high of roughly 812 and a swing low at the bottom near 786. During the session, the market was unable to hold above the 38 percent retracement level, suggesting lower price action into the close. It did break through that level three times throughout the day, and also above the 50 percent level, but the close didn’t provide confirmation of the move to indicate a buy signal.
The arcs show the test of 38 percent and 50 percent levels, and the timing it took to complete the moves. The market did fail and closed near its lows final few minutes of the session.
Fibonacci analysis can be complex, and this was a fairly brief and broad overview of how Fibonacci retracements and arcs can be used in your trading for price and timing projections. I encourage you to contact me if you have questions about this topic, and how you might incorporate this type of analysis into a possible trading strategy for today’s market action.
Dennis G. Cajigas is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at (866) 631-6216 or by email at dcajigas@lind-waldock.com.
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