FIBONACCI PROJECTIONS

A Fibonacci projection is simply the determining of a potential price ob jective and is a vital component in Elliott wave theory. It is an excellent confirmation tool to identify potential trend-exhaustion turning points. Figure 6.3 shows how to determine a bullish upside objective by measuring the range of the wave, or the swing, as it is also called. Multiply that sum by the corresponding ratios, which are 0.618 percent; 1.00 percent; 1.618 per cent; 2.618 percent; and, for extreme moves, 3.618 percent. In a bullish trend, add that figure to the low, or point C, which is the correction low; this will give you the projected extension price objective.

Figure 6.4 shows how to use the Fibonacci ratios to determine bearish price projections. If point C is a correction, take the measurement of A - B, multiply that amount by the corresponding Fibonacci ratio, and subtract that figure from point B, which will give you a downside price objective, or the targeted support level of point C.

As you examine Figure 6.5, which is a spot euro FX, you will see how to effectively use the Fibonacci tool. If in a given time period that the pivot point analysis or pivot support or resistance numbers have hit you are look ing for further clues as to price direction or support or resistance levels within the pivot numbers, Fibonacci will be your greatest tool. Once we in dicate what the established low is at point A, as the market rallies, we see a top, which is formed by a doji. All that is needed is to figure what the pos sible support or targeted low will be on the correction. Point C is the exact 50 percent retracement on the pullback. One of the most important ele ments to watch here is this: If the support holds and is a valid spot to buy the retracement, then you want the market to continue to close above the support numbers. That is exactly what happens here.

Let's see how we would use the Fibonacci extension method to estab lish an upside price objective. Take a look at Figure 6.6: The first step is to establish the low, shown on the euro currency chart as point A. Then as the peak, or top, is determined at point B, we would extend that distance by

1.618 percent or 2.00 percent. If the market respects a 50 percent pullback and begins to resume the uptrend, using a Fibonacci extension tool will help alert you to a profit target. As I stated before, I like to think that a mar

ket that is in sync with the Fibonacci ratio numbers stays in sync with Fi bonacci price objections. In this chart, the pullback was 50 percent of A B move, and the market held the Fibonacci extension resistance targets.

Fibonacci works with day trading to determine support and resistance levels within the pivot point areas as well as to help forecast the projected ranges. Figure 6.7 is a euro currency chart that shows the daily pivot lines with the 0.38 percent retracement level. The Fibonacci correction tool can be used as a way to identify whether the trend will reverse or continue. Let's study the chart in Figure 6.7. The market is already on a downtrend; if you missed the sell signal at the very top, when do you join the trend and sell or look for a buying opportunity? As the market establishes a bottom, as indicated at point B, using the Fibonacci tool, we see the correction levels indicating resistance at the 38 percent, 50 percent, and 618 percent re tracement areas. Point C stops dead on a dime at the 38 percent level.

In fact, that reversal triggers a sell signal using the pivot point moving average method; and as you can see, the market resumes the downtrend. The arrows illustrate a sell signal as the market closes below a prior low and below the moving averages. It was the rejection of the Fibonacci 38 percent resistance that helped confirm a trading opportunity. If you take a short position at the 0.38 percent rejection level, you should use an initial stop-close-only above the high at point C and then adjust the stop-loss accordingly. This means we change from a mental stop-close-only to a hard stop; then, depending on whether you scale out of a portion of your position, you adjust your stop according to how many lots you have left on.

Here is how you can put Fibonacci correction levels to good use while integrating them with pivot point support and resistance numbers. This is a technique that is more in line with what day traders will encounter on a more frequent basis. Figure 6.8 shows a 15-minute chart on the Aussie dollar. As you can see, the market moved into a bullish trend mode early, only to stall at the projected pivot resistance level. The high of the session is formed by a doji, which indicates indecision. No call to action is made just yet; as a system or rule-based trader, you need to wait until there is confir mation of a breakdown of either support or a conditional change in prices by a series of lower highs, lower closes than opens, lower lows, and closes below prior lows. Most important, you want confirmation of a sell signal when the market closes below the low of the doji.

The trigger to sell would be on that candle's close or the next time pe riod's open. The stop would be placed initially as a stop-close-only above the high of the doji. Immediately, we see instant gratification as prices plunge. But as what can normally occur is an upside correction that takes place, in this example, the correction takes the form of a consolidation period that lasts nearly one hour and forty-five minutes. This period of inde cision can create havoc, doubt, and uncertainty; and your mind can start to play tricks on you.

This is the consolidation period that generates indecision. At this point, you have a good setup, prices have violated support, resistance has held, and there is a high-probability pattern that you recognize that generates re liable price action, namely the low close doji sell signal. But you are faced with these internal forces that may cause you to exit a well-defined trade. After all, you have a risk factor and a potential reward objective already mapped out. However, this consolidation period is creating more and more doubt about whether you should stay in the trade. Here is when you need to take advantage of the time the market is in the pause period and go to work. You now have a distinguishable high and a low made. Using the Fibonacci ratios, you determine the correction levels. As such, you have iden tified that the 50 percent and the 0.618 percent Fibonacci retracement levels are holding the market down.

Armed with this information, you will not be surprised or forced to react emotionally when prices rebound but do not penetrate above these levels. As Figure 6.8 shows, the correction hits the 0.618 percent retrace ment level as defined by point C and almost immediately prices collapse. The market rewards the disciplined and patient trader, as such Fibonacci correction levels will help you to identify what I consider pattern traps. What generally occurs in order for the market to finally fall out of bed, like it does as shown in Figure 6.8, is a period of time to consolidate and attract buyers. It is within this congestion period, when it fails to support and prices breach below the lows, that traders are forced to sell like mad. This setup was a textbook sell signal as this book has taught you from the be ginning. There was little to no heat to take on the trade. It did require pa tience and discipline to see the trade through. But this is how the Fibonacci tool can work in your favor. Use the Fibonacci tool to help you uncover the hidden resistance levels within a newly defined trend and stay on the right side of the market longer.

I prefer pivot points, but the fact is that no single tool is the holy grail. There are many instances where Fibonacci studies outperform pivot point analysis to help target price-measurement objectives. There will be times when the daily pivot numbers will not come into play as they will be too far away from the current market price or the market will blow right past them, for example, if a prior trading session has an unusually small-range day and then, during the following session, a major report or event wreaks havoc on the market. With an increase in volatility, we can assume that there might be an expanded range and that the pivot support or resistance numbers may not be as effective. This is where you can harness the predictive power of the Fibonacci correction or extension technique to help uncover hidden value areas.

In Figure 6.9, using the Fibonacci extension tool, once we have the high identified, as shown at point A, we need to look for a low point, or a re actionary low, as it is called. As the chart shows, the price action blows right past the daily predicted pivot point support level and forms point B. The market now goes into another consolidation phase, in which we can see the pivot support level now acting as a resistance level as prices hold at point C. By using the Fibonacci extension tool, we can determine how far the market can decline. The first objective is the 1.618 percent extension and the next level is the 2.00 percent objective—point D on the chart. This technique really does help you determine a good profit target objective when all else fails.

The reason why this is a valuable tool is fairly obvious: If you are scale trading and peeling off positions and milking the trade by trailing stops on portions of your positions, the Fibonacci tool gives you profit target levels so you let the trade run. All that is needed is to manage the trade set orders to cover shorts at these hidden target levels. This book comes with a Fi bonacci calculator that includes the correction and extension tool. I believe that if you are new to trading and do not have a charting software package that includes this feature, you will find the CD extremely helpful. Once you determine the calculations, you can simply use a drawing tool on your charts with the figures. I have included a simulated demonstration on the CD as well.

SUMMARY

Fibonacci analysis is not complicated when using the numbers as a tool to determine retracement levels for intraday trading. I find that pivot points on the various time frames, such as daily, weekly, and monthly, work more effectively more times than not; so for me, Fibonacci is doing double the work for longer-term analysis. However, with the software like Genesis, it certainly does not hurt to use Fibonacci analysis; and it works extreme ly effectively for day trading corrections on strong-trending days. The narrow-range days, where pivot analysis will be ineffective for the most part, will occur but not that frequently; but when these narrow-range days occur, I believe you will be glad you know how to use and apply Fibonacci calculations.