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This technique is very similar to using speed resistance lines. Fibonacci
numbers are frequently used to hypothesize which rates particular assets
will gravitate towards. Use of these numbers is widely accepted in the
currency market. There are four popular types of Fibonacci studies, arcs,
fans, retracements and time zones.|
In 1170 A.D., Leonardo Fibonacci a mathematician, discovered the relationship that is now referred to as the Fibonacci numbers while he was studying the Great Pyramid of Gizza, in Egypt. The Fibonacci ratio exists between any two successive numbers in the Fibonacci sequence. The numbers are a sequence of numbers for which each successive number is the sum of the two previous numbers. For example: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 etc.
When the market is moving rapidly in any given direction, it sometimes
experiences breaks where investors simply hold on to their profits. This
phenomenon is known as retracements and generally creates good
opportunities for investors to re-enter the market at some attractive
levels before the move resumes. Retracements are usually similar in size.
Technical traders in particular, pay considerable attention to
retracements that are at the Fibonaccio ratios of 38.1% and 50%.
This is an hourly chart of USD/JPY. Here we plotted the Fibonacci Retracement Levels by clicking on the Swing Low at 110.78 on 07/12/05 and dragging the cursor to the Swing High at 112.27 on 07/13/05. You can see the levels plotted by the software. The Retracement Levels were 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618). Now the expectation is that if USD/JPY retraces from this high, it will find support at one of the Fibonacci Levels because traders will be placing buy orders at these levels as the market pulls back.
Now letís look at what actually happened after the Swing High occurred. The market pulled back right through the 0.236 level and continued the next day piercing the 0.382 level but never actually closing below it. Later on that day, the market resumed its upward move. Clearly buying at the 0.382 level would have been a good short term trade.
Now letís see how we would use Fibonacci Retracement Levels during a downtrend. This is an hourly chart for EUR/USD. As you can see, we found our Swing High at 1.3278 on 02/28/05 and our Swing Low at 1.3169 a couple hours later. The Retracement Levels were 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236). The expectation for a downtrend is if it retraces from this high, it will encounter resistance at one of the Fibonacci Levels because traders will be placing sell orders at these levels as the market attempts to rally.
Letís check out what happened next. Now isnít that a thing of beauty! The market did try to rally but it barely past the 0.500 level spiking to a high 1.3227 and it actually closed below it. After that bar, you can see that the rally reversed and the downward move continued. You would have made some nice dough selling at the 0.382 level.
Hereís another example. This is an hourly chart for GBP/USD. We had a Swing High of 1.7438 on 07/26/05 and a Swing Low of 1.7336 the next day. So our Retracement Levels are: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). Looking at the chart, the market looks like it tried to break the 0.500 level on several occasions, but try as it may, it failed. So would putting a sell order at the 0.500 level be a good trade?
You can see from these examples the market usually finds at least
temporary support (during an uptrend) or resistance (during a downtrend)
at the Fibonacci Retracements Levels. Itís apparent that there a few
problems to deal with here. Thereís no way of knowing which level will
provide support. The 0.236 seems to provide the weakest
support/resistance, while the other levels provide support/resistance at
about the same frequency. Even though the charts above show the market
usually only retracing to the 0.382 level, it doesnít mean the price will
hit that level every time and reverse. Sometimes itíll hit the 0.500 and
reverse, other times itíll hit the 0.618 and reverse, and other times the
price will totally ignore Mr. Fibonacci and blow past all the levels like
similar to the way Allen Iverson blows past his defenders with his nasty
first step. Remember, the market will not always resume its uptrend after
finding temporary support, but instead continue to decline below the last
Swing Low. Same thing for a downtrend. The market may instead decide to
continue above the last Swing High.
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