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Fibonacci Retracements

Posted by Larry Doyle on March 6, 2009 12:40 PM |

I am going to assume that for the general public, the term Fibonacci Retracements is not part of the normal vocabulary. In helping people navigate the economic landscape, allow me to introduce you to a basic Wall Street practice utilized by many traders. Every investor can benefit from a basic understanding of this concept.

Major market indices trade based on fundamental analysis (cash flow, asset/liability, earnings ), technical analysis (price regressions), and psychology (measure of bullishness vs bearishness). Our friend Fibonacci falls into the technical analysis camp. I do not want to get overly involved in the arcane aspects of this concept, but it can be very useful in assessing market levels and market directions.

Essentially, Fibonacci developed a series of numbers that have become commonly used in trading to predict support and resistance levels in the market. These numbers are .238, .382, .50, and .618. For our current purposes, we can use these numbers to chart price action and predicted price levels for any index. Let’s use the DJIA. This average topped out in October 2007 at approximately 14,200. One does not pick random numbers for purposes of using this analysis. In using a defined market top or bottom, we can then predict intermediate term support or resistance levels.

From 14,200, predicting retracements of .238, .382, 50, and .618 would give us levels on the DJIA of approximately 10,850 (14,200 – 14,200 x .238), 8775 (14,200 -14,200 x .382), 7100 (14,200 – 14,200 x.50) and 5425 (14,200 – 14,200 x .618).

For what it is worth, the market spent the better part of three months (Oct 2008- Jan 2009) rotating around that 8775 level. The market had bottomed at 7100 back in late 2002 and closed at 7063 at month end February 2009. The fact that the market so quickly took the 7100 level out —  without so much as a bounce or a few weeks, if not month, of price action —  strikes me as decidedly bearish. The next support level using this analysis is 5425!!

While I hope this review is not too technical for our readers, please understand it is purely based upon price regressions and the key Fibonacci numbers were derived from extensive research. Many traders use this analysis which leads me at times to believe that the analysis is self-fulfilling.

While some traders and investors may base all of their moves on this technical analysis using Fibonacci numbers, I certainly do not and would caution anybody in taking that approach. However, I am always aware of what the Fibonacci retracement levels are as I go about analyzing the markets.


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