Fibonacci Spiral  
 

Fibonacci Analysis

Constance Brown, CMT

Bloomberg Press New York


Chapter 3: Fibonacci Support, Resistance, and Price Projections offers you an example of how fibonacci ratios can be used to create support, resistance, and expansion price targets. The book Fibonacci Analysis goes into far greater detail on the correct use of creating confluence zones by overlapping fibonacci ratios. The targets are used for market entry, exit, and risk management. The hardcopy is recommended by other readers.

Book questions? Please send them over to twitter @AeroinvestBrown


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Chapter 3: Fibonacci Support, Resistance, and Price Projections

In the last discussion, Figure 2.16 defined two Fibonacci confluence zones that formed within the 3-day Centex Corporation chart. Our purpose for defining these target confluence zones was to enter a short position in a developing trend. The intraday charts showed the market should not exceed the zone above, and we knew therefore to place stops over the next target zone. Stops are not within the zone, but just above the zone. Longer-horizon traders would have made the same calculations but might have needed to consider their stop exit level above one zone higher again. In Figure 2.16, we did not create the third confluence zone, but we will do so as these examples unfold.

As we know where to sell and where to put our stop, we need to know now where the market is going to complete a risk-to-reward ratio for our risk management needs and position size determination.

The two confluence zones derived from different Fibonacci ratios created in Figure 2.16 are seen passing through point a in Figure 3.1 and extend across the chart. On the far left, the ranges used to create these zones are still visible. They have dots on the calculations. They can be deleted once a horizontal line has been added to mark the two confluence zones at 45.56 and 43.97, as they are not needed any longer. Both charts show the 3-day Centex Corporation data but Figure 3.1 now shows the market decline that formed after the short position entry at point a.

fibonacci price projection

FIGURE 3.1 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Copyright © 2008

The question to answer was, how do we determine the price target if we sell into point a? The easiest method is to draw a box marking the range from the higher confluence zone at $45.56 to the market high in this chart. A box is used just to measure the range. So the width of the box has no meaning in this application, just its height. I draw a second box over the first and drag the second box, being careful not to change its dimensions, to a position that starts at $45.56 and mirrors the first range. The range of the box ends at $12.26. That is a target too far away from the entry level at $43.97. (The price is on the left of the zone's horizontal line.) As I know I can add, subtract, divide, and multiply ratios, I elected to subdivide the new box with a Fibonacci retracement tool to determine the 38.2, 50.0, and 61.8 percent ratios within the box. A rational target in my comfort zone is the first level at $32.84. From this single projection, I do not know if my target will be minor or major support. I do not know what probability to give this target either. While it is a valid target, I have other ways to accomplish this task that experience has shown is better. This method is very useful for the Elliott Wave challenged trader. There is no wave counting involved. Just a simple use of mirror geometry and you have a good start when your indicators confirm.

At price lows 1, 2, and 3, the market is respecting the zone created at $45.56 that was used to create the equality mirrored swing using the boxes. There is a reason this works and I'll defer that discussion until the next chapter. Our focus will remain on the methods used to create the price targets.

If the market reaches price low 3, you may find a bounce that your indicators warn will lead to further losses. If you know the Elliott Wave Principle, it is easier because you would see an incomplete wave structure in the decline into the low at point 3. Momentum oscillators would also warn a final bottom is not in place. Whatever method you use, there is a big spread from the 61.8 percent line that runs through price low 3 and the bottom of the box at $12.15. So subdivide the last range from the 61.8 percent ratio at $24.98 and $12.15. (You will find $25.09 in the chart, as the tools used were deliberately spaced different so you could see them. This is also true for $12.15 and $12.26 that end ranges.) This decline is incomplete but a bounce will form.

How do I know a bounce will develop? My indicators are used only when the market reaches a target zone. The indicators then give me permission to develop a trade strategy or warn when my exit plan should be followed immediately. Part of the exit plan might be to unwind a portion of the trade and add that portion plus x percent into the bounce. By focusing on momentum indicators only at the zone, this method filters out premature and false signals. I will look at oscillators again in Chapter 5.

How do I know how high the bounce will go? I repeat the process all over again by starting from a price low to calculate resistance levels and take subsequent price bar highs that started a strong thrust down within the decline.

But how can I be confident this is the price support level the market will respect for a significant rebound? From this simple method alone, I cannot answer this latter question. For this reason, we need to continue.

In the chart in Figure 3.2, you are going to use more of the in- formation and observations we developed in Chapter 2. In Figure 3.2, you see the same box from the high to the zone at $45.56. But flipping the box down to produce a mirrored target overlooked two important facts about this data set. The first thing never considered was the gap near $58.18. If you page back to Figure 2.10, you will see a specific measurement was taken because the gap was in this chart. The other fact not considered was the price low, A, in Figure 2.10. We talked about why that price low was used rather than the key reversal swing down that followed shortly after this move. We discussed how the probability, and hence our confidence of being right, was confirmed when the market showed respect to the results in hindsight within Figure 2.11. Plus we cannot overlook an important point . . . we were right! When studying Figure 2.11, we found the market failed after a corrective rally into the 50 percent retracement. All this information is evidence why this market is declining. In the example for Figure 2.11, we had not discussed confluence zones, but price low B in Figure 2.12 is a major factor in what we are considering now.

In Figure 3.2, you see the confluence zone at $43.97 from the work in Chapter 2 in Figure 2.13. The market is saying this price low is one of the key levels it is using to build future price swings. We have to use it. The upper box dimensions in Figure 3.2 are the same as Figure 3.1, but now we are going to project the box down from the lower confluence zone at $43.97 that we know is a major marker for this market. The spacing between the two boxes, or confluence zones, is the same width as the gap. No surprise, as often markets use the gaps as measuring features elsewhere within a chart. By knowing we gave consideration to the gap and the key level at $43.97, we know we have built upon the earlier knowledge the market gave us. Our targets will be more accurate, though we need to define confluence zones to identify the difference between major and minor support targets.


Fibonacci price ratio targets

FIGURE 3.2 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

In Figure 3.2, the market has fallen to a level at $18.52 that allows us to consider another proportional subdivision of the lower box. The lower box was subdivided into 38.2 percent, 50 percent, and 68.2 per- cent ratios, and the prices are at $31.41, $27.53, and $23.65 respectively. In Figure 3.2, we also created a box between the 38.2 percent line at $31.41 and the current price at $18.52. When this smaller box is subdivided, we discover a confluence zone where an overlap forms at 23.52-23.65. This confluence zone is marked c1 and will prove to be important. All other lines in box a from $31.41 will be secondary. Why? The other Fibonacci ratios all stand alone.

The next chart in this series of 3-day Centex Corporation price projections is Figure 3.3. This chart shows several ranges subdivided, and additional confluence zones at $18.52 and $15.76. Draw a horizontal line at any confluence zone. The reason is found in Figure 3.4.

fibonacci support levels

FIGURE 3.3 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

The reason you want to draw horizontal lines through the confluence zones, in some cases marking the highs and lows of the range itself, is you can delete all the other details from your screen. Most of the Fibonacci lines and boxes are deleted leaving a clean screen in Figure 3.4. Now other methods will use these confluence levels that we will discuss at another time.


fibonacci chart with targets

 

Figure 3.4 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

We know the gap near $58.18 is important. We also know gaps often form 50 percent subdivisional lines within the developing price geometry. You will use these facts now to your advantage. Define a box from the middle of the gap to the price high. This first box is marked d in Figure 3.5. That will become your arithmetic mean within a proportional equation that you need not write as a formula to understand.

fibonacci extension

Figure 3.5 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

Copy the box and create a mirrored placement under the first box. The new box in the middle of the chart is marked e. Within box e, you will subdivide the height of this box into the Fibonacci ratios. Take notice of the ratio that forms at price $44.01. All the old ranges that defined the two confluence zones in Chapter 2 are visible in this chart. The confluence zone at $43.97 that crosses the critical pivot at price low B has just been confirmed again. You are using different methods, and finding the price low at B and the midpoint of the gap continues to anchor key measurements. This is exactly what is meant when I said the market forms milestones that tell what key levels are being used to form future swings. All these calculation are derived from the market decline without benefit of the market data that formed in the rally. The reason for not showing the data in the rally is to learn how to do this when it is hard because new price lows are developing. The same methods apply when the market is breaking into historic new price highs. We will look at that scenario, as it is fitting for China, India, Australia, and many of the equity markets being dragged up by these indexes. But this 3-day Centex chart is building the skills you need to tackle the tough international scene we will discuss later.

Figure 3.6 is the third box in the series. Move a copy of the first or second box down to the bottom of the second box in the Centex Corporation data. You will again subdivide the range in the third and lowest box. Level e, or the 50 percent line, is respected by a small bounce up before the market works its way lower. Level d is also respected as resistance if you trace line d back to the left to pivot d1. Price level c shows how the market will use the Fibonacci ratios at c2 as support, and c1 as resistance. (In Figure 2.12, c2 is level B.) The math would look ugly, but the geometric visuals are very easy to use and read. This is why Plato used geometry to explain the ratio that binds all things together and not the Fibonacci numbers that produce irrational numbers.

fibonacci retracement

Figure 3.6 Centex 3-Day Chart

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

 

 

An Introduction to Fibonacci Expansion Price Targets

Another method widely used by swing traders is to select a range, as you see in Figure 3.7, and then project the 0.618, 0.50, and 1.618 relationships from a key price pivot. Figure 3.7 shows the 3-day Centex Corporation chart and the selected range from the high at point A and the now familiar price low at point B. Most people will use the price low to the right of point B where it appears to be the end of the swing. You are not going to use that lower pivot because of the important relationships we uncovered earlier in this chapter at B. The high of the corrective rally that follows into X is then used to start a Fibonacci expansion price projection. The 0.618, equality (1.0), and 1.618 proportional relationships are the industry standard ratios created from the range AB. Most books use diagonal lines to mark the swings being created; however, this is mathematically incorrect. You never give the slope or measurements on a diagonal axis any consideration.The projections are always parallel to the y-axis, as you see in Figure 3.7.

fibonacci expansion price target

Figure 3.7 Centex 3-Day Chart - Creating Fibonacci Expansion Price Targets

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

Now we need to study Centex's longer-horizon data in Figure 3.8 that leads into the price highs. We will need to define additional confluence zones within this data. All the charts from Figure 2.8 to Figure 3.7 kept us from seeing this data so it was clear we couldn't be influenced by the historical data behind the most recent downtrend. As I created the charts, I deliberately kept myself from looking back as well. Therefore, I am looking at the long-horizon data myself for the first time in this analysis discussion. The first thing you know: to start a support calculation, you must start from a price high and drag down to a price low. The question is where do you start the high? There is a key reversal next to point c. I normally truncate the starting key reversals for these range selections. But I have to stop myself in this example. There is a double top and both tops produced key reversals. Strong directional signals should not be truncated. So this chart demands you start the range to be subdivided from the price high.

fibonacci ratios

 

Figure 3.8 Centex 3-Week Chart - Longer-Horizon Data

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.

 

In Figure 3.8, the box corners of the selected ranges are marked. The first range is from the price high aligned near c to the lower price range at d. Why d? I find in my seminars everyone understands the concepts and then they get confused before the computer to do this. Nearly everyone has trained their eye to look at the price extremes that form the major swings, but they have never looked at the internal details of the data. So I know this is new for the majority of readers. We are looking to select a price low that starts a major price move. The price low that aligns with d is clearly the start of something strong, forceful, and relentless. The data that immediately leads into this explosion shows a period of higher highs and higher lows that form a back-and-fill coil. Take the low that finally breaks away from that preparation. These are the areas that let us adjust and stay in sync with the different contraction and expansion proportions developing within all markets. They are unique. They require us to read the data.

Behind the market high, I see lots of price lows with strong forceful moves within the rally, but you are trying to find the first levels of confluence that may be near price low B. The second range will again start from the high. Always begin from the same level. Then the price low for the second range stops at f. As I dragged my mouse down to look at the swings under the low of the first range at d, I found that the Fibonacci ratios were just noise within the chart. This is why you have to start from a price high to define support. If you start from the bottom, you have no other option than to pick the final high. If you stay with your vendor's thinking, you will always remain a beginner. I never complained when I managed a fund, as I knew most vendors locked the majority of traders out of using these methods. But later I learned from writing a report for investors and institutions, that you can advertise your exact price target and still be able to use it. Everyone has to tweak his or her results. It is amazing to me that exact price zones never seem to be messed up when large trading firms have been notified of their location.

In Chapter 5, we will study how to create price objectives when markets are moving into new market highs. You will see that the confluence zones we are developing within Figure 3.8 will be used to project future price targets for new market highs.

A smile came across my face when the second range was completed in Figure 3.8. The subdivided ranges cd and ef define a confluence zone right along the price level that intersects the much referenced price low B. No surprise to me as this will happen all the time. Use any time horizon, any Fibonacci projection method correctly, and the most significant milestones within the data set will always reappear. But if you never create multiple projections, you'll never know where they are hiding. You now know you were correct to use the price low at B and not the actual low that fell just to the right of it in all your prior calculations. This area is marked with a horizontal line that runs across the entire chart. It is also an exceptional chart to show why short-horizon traders must work with long-horizon charts as well and vice versa. There will come a day when the short-horizon trader's data will tell the trader point B is important. But just how important is unknown unless you work with this longer-horizon data as well.

One last comparison has been added for you in Figure 3.8. The confluence zones developed earlier at levels h1 and g1 have been extended to the left at h2 and g2. I want to use this opportunity to reinforce an earlier comment that markets will show respect to these confluence zones in the future and in the past. In this chart, a major spike reversal developed just to the confluence zone g2. The spike reversal is just to the right of the label g2. Notice also the lengthy consolidation that developed along h2 into the 1998 and 1999 highs.

Figure 3.9 shows Centex in a 6-month bar chart and becomes a rather dramatic clarification how confluence zones, derived from shorter time horizons that appear multiple times, may have long horizon implications for a market. Look at price low B and the corresponding breakdown three bars to the right with a down arrow. This zone was calculated from different approaches and entirely different internals, but each time we had a sense something important was forming at this price level. In this time horizon, it is clear the price zone at $43.48 to $43.87 was the most significant pivot point.

fibonacci

Figure 3.9 Centex 6-Month Chart - Short Time Horizon targets with Longer-Term Price Projections

Connie Brown, www.aeroinvest.com. Source: Copyright © 2008.


You are reading to focus next on rally examples and walk through the steps needed to create price targets for markets making new market highs in Chapter 5. In Chapter 6, we will address some of the problems that develop in different price character, such as contracting triangles, which warns when a market is rescaling. We will also cover adding technical indicators and other methods so you know what action to take when a market reaches a target zone. But before we move forward with more charts, this is a very good place to digress and explain why these methods work the way they do. It also goes back to an unanswered question you still may have about how to transfer the Fibonacci spiral into two-dimensional charts. Learning how to see the mysterious thread that connects the spiral galaxy (see Figure 3.10), the nautilus shell, your DNA, and great masterpieces in art and music, including architecture such as the Colosseum in Rome, follows next.

FIGURE 3.10 Is the image at the top of this page in color. Galaxy Messier 101, Hubble Image: NASA and ESA, February 28, 2006

Acknowledgment: K.D. Kuntz (GSFC), F. Bresolin (University of Hawaii), J. Trauger (JPL), J. Mould (NOAO), and Y.-H. Chu (University of Illinois, Urbana

If you would like to learn more about Fibonacci Analysis please refer to the book. 'Fibonacci Analysis'