Monday, 16 December 2013

Fibonacci Numbers and their Significance in Trading

A lot of the times, when the market is moving at its terrific speed, we are unsure whether the price we are buying or selling at is correct, and if the price of the stock will go further up from here and vice-versa. Since we are not sure of the point of the change in trend, we often either BUY and SELL too late, or BUY and SELL too early. Fibonacci numbers help us at these points to determine what could be the highest range the stock may reach for the day and vice versa.

Fibonacci tools unlike a lot of the other tools in the market are not trailing indicators but leading indicators.

Fibonacci tools allow you to track retracements and extensions. So what exactly is a Fibonacci retracement? A Fibonacci retracement is based on the fact that Stocks will often pull back or retrace a percentage of the previous move before reversing their direction.

Fibonacci retracement is created by taking two extreme points on a chart and dividing the vertical distance between the two by the key Fibonacci ratios. 0.0% is considered to be the start of the retracement, while 100.0% is a complete reversal to the original move. Once these levels are identified, horizontal lines are drawn and used to identify possible resistance and support levels.Fibonacci retracements often occur at the following levels: 23.6%, 38.2%, 50%, 61.8%, 100%.

Even though Fibonacci retracements work best over a longer time-period they can be pretty useful for getting into short term trades as well, when used along with MACD and stochastic oscillators.



Here is a snapshot for LNKD chart which mainly had a downtrend yesterday. For the second wave in the day, the high is at 231.29 and the low is at 227.59 which gives an approximate retracement of 50% at 229.42 and retracement of 61.8% at 229.85%. Since this was a downtrend, the retracements were pulled down before they could reach the 61.8%, indicating a further downtrend in the day. If you notice the next high is at 229.64.

So here even though it is a single day chart, the Fibonacci retracement still helps to more or less predict at which point one should sell, to reduce their losses during a downtrend.

Now lets us look at FB which was on an uptrend yesterday.




It's first high for the day was 54.46, and the subsequent low was 53.77 which gives an approximate retracement of 54.29 at 76.4% and 54.19 at 61.8%. The next  subsequent highs were 54.16 and 54.24 which were just below the 76.4% and 61.8% mark indicating that even though it was in an uptrend, it was not strong enough to cross these marks, and hence starting on a downtrend with the next high not able to cross 54.16 again.


So here even though it is a single day chart, the Fibonacci retracement still helps to more or less predict at which point one should sell in a single day trade, to reduce their losses during a downtrend.