THIS MONTH S STORY. Fibonacci Retracements The Classic

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1 THIS MONTH S STORY Fibonacci Retracements The Classic Author: Cornelius Luca, Eikon Charting Product Manager Tel: Welcome to the fourth edition of the charts newsletter! Brought to you by the charting product management team. Follow me on My Eikon and get my Chart of Week commentary. Most trends wave their way either up or down, rather than unfolding without discernable pullbacks. Thus, most trends are subject to price retracements. Whether focusing on equities, FX, fixed income or commodities, Fibonacci retracements are a common feature for traders who gauge the state of market trends and the magnitude of their corrections. This analysis is so common that it has become overused at times; neverthelessyet, traders who use the Fibonacci ratios in a complete and disciplined manner achieve good results. This is the first in the series of letters focusing on how using Fibonacci ratio in a consistent style can enhance your trading and analytical skills. Classic Ranges to Retrace Traders continuously seek targets, and trend retracements provide the tools. Traders therefore search for a trend with a clear starting point and a clear (at least apparent) end. Select the lowest low and the highest high for the range of an uptrend, and the highest high and the lowest low for the range of a downtrend; and then let the software work its magic. The software will not automatically select the range of the trend;, but this is actually a good thing since not everyone likes to analyze the same trading ranges. We will analyze variations of ranges to retrace in the future letters.

2 Figure 1 shows the extreme points of an uptrend in euro/dollar. The start of the range is marked by a blue circle and the end of the range is marked by a pink circle. This range was subsequently retraced with Fibonacci ratios. Retracement Ratios Which Ones? While most traders use Fibonacci retracements, for good order, one should emphasize that there two other sets of ratios under consideration. Charles Dow used 33%, 50%, and 67%. More recently, the famed trader and analyst W.D. Gann plotted his retracements at 12.5%, 25%, 37.5%, 50%, 67.5%, 75%, and 87.5%. Surely, It is likely that everyone the majority of people already knows about Fibonacci s 38.2%, 50%, and 61.8% ratios. Let s see their origin, and while at it, let s also add a few more ratios for a complete set. Feel free to experiment with other ratios. Changing them is a breeze! Fibonacci Retracement Ratios Nuts and Bolts Each number in the Fibonacci sequence is the sum of the two preceding numbers. The Fibonacci sequence starts with the numbers 0, 1 and continues 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, For instance, = 89.

3 The core Fibonacci ratio is 61.8%. A popular method of calculating it is to divide 55 by 89. These numbers are immediately adjacent to each other. To calculate the next well known ratio % - either divide 34 by 89, or subtract 38.1% from 100%. We arrive at 23.6% by dividing 21 by 89 or 61.8%*38.2%. Its correspondent ration on the other side is % - is arrived at as follows: 38.2% % +61.8%. Some users like 78.6%, which is the square root of 61.8%. Then, we should also use 14.6%, which the difference of 38.2% %. Its correspondent ratio is 85.4%. So, 100% % = 85.4%. We started with 3 ratios: 38.2%, 50% and 61.8%. We are ending with the full set of Fibonacci retracements ratios: 14.6%, 23.6%, 38.2%, 50%, 61.8%, 76.4% (or perhaps you prefer 78.6%), and 85.4%. Figure 2 shows a full set of Fibonacci retracements on the weekly CBOT US Treasury 10-year Note continuation future. It s important to plot the full set of Fibonacci retracements in order to create a clear set of support and resistance levels. Price Behavior at Fibonacci Retracements I ve seen many traders simply waiting to see if their market will find support from the 38.2% Fibonacci retracement of an uptrend before liquidating long positions. Since risking nearly 40% of a move might be a tall order, we should try more manageable levels.

4 Traditionally, the weakest of the ratios are 14.6% and 85.4%. So, when we experience a pullback from an uptrend, 14.6% retracement should easily give way. If this happens, then the next target is the 23.6% retracement. In Figure 3 you can see that the 14.6% retracement of the Morgan Stanley (MS.N) uptrend easily gave way; however, the 23.6% held. For two weeks, the trading range was generally delimitated by the 14.6% and 23.6% retracements. What is the technical significance? The ability of the 23.6% Fibonacci retracement to hold suggests that the MS.N s uptrend is in good shape and stands a strong chance of to attempt reaching a new high. Similarly, the odds of a new high for an uptrend or a new low for a downtrend are even better when the 14.6% holds. Figure 3. The 23.6% Fibonacci put a floor under the up trending Morgan Stanley s retracement. In another example in Figure 4, you can see the pullback of gold (XAU=) on the decline plotted on a 5-minute chart. The 14.6%, 23.6% and 38.2% Fibonacci retracement were obliterated; however, the 50% capped, so the immediate trading range became 38.2% to 50%. If the former gives way, then the trading range will become 23.6% to 38.2%.

5 Figure 4. The pullback of gold (XAU=) on the decline plotted on a 5-minute chart was capped by the 50% retracement. The fortunes are not so good, however, for the uptrend of the CBOT US Treasury 10-year Note continuation future seen in Figure 2. The contract only found support from the 61.8% Fibonacci retracement and is trading in the range between this ratio and 50%. Thus, the odds of resuming the uptrend are low. Different Time Horizons Different traders follow different time horizons, so it s important to include all significant trend frames in Fibonacci analysis. In Figure 5 I plotted three Fibonacci retracement sets on the Nikkei 225 Index (.N225) weekly chart, as follows: 1. The uptrend between October 2012 and May 2013 (yellow), 2. The uptrend between January and May 2013 (blue), and 3. The down move between May and June 2013 (pink). Generally, traders look for the closest retracement to the current price. Such a level or area - support or resistance - becomes more significant if it is a confluence of different time horizons. In this example, the.n225 is challenging the 14,600 area of resistance, which is the confluence of a 23.6% Fibonacci retracement of the uptrend between January and May 2013 (blue) and the 61.8% Fibonacci retracement of the down move between May and June 2013 (pink). This should be a strong resistance, so the behavior of the Index at this area should dictate the next direction.

6 Figure 5. The confluence of Fibonacci retracements from various time horizons tends to provide stronger support or resistance areas. Different Periodicities After setting a Fibonacci retracement set on a weekly chart, for instance, it s a good idea to change periodicity in order to mine for information about the strength of supply and demand. The more time a market spends at a certain level, the more significant that level is. So, if you plotted your Fibonacci retracements on a weekly chart, perhaps you should change that periodicity down to daily, hourly, 5 minutes. Typical Behavior of Fibonacci Retracements When retracing ranges measured from the lowest low to the highest high (and vice versa), the Fibonacci retracements tend to act like magnets to the price. Magnets both attract and repel (when poles are reversed). Likewise, the Fibonacci retracement lines may be touched, briefly penetrated, or closely approached, but not touched; and yet they will retain technical significance. These different performances show various market behaviors. If the Fibonacci retracement is reached but holds, this might suggest a lack of strong orders or conviction at those levels. If the

7 Fibonacci retracement is only briefly penetrated, this might mean that some traders mined for stop-loss orders, failed to trigger them, and so they quickly covered their losing trades. If the Fibonacci retracement is closely approached, but not touched, this might suggest either large orders placed at that level, or the defense of the barrier of a digital option. Good luck! Take Away In classic Fibonacci retracement, select the lowest low and the highest high for the range of an uptrend, and the highest high and the lowest low for the range of a downtrend. Use a full set of Fibonacci retracements ratios: 14.6%, 23.6%, 38.2%, 50%, 61.8%, 76.4% (or perhaps you prefer 78.6 %?), and 85.4%. Plot as many Fibonacci retracement sets as needed. A line becomes more significant if it is a confluence of different time horizons. The Fibonacci retracements tend to act like magnets to the price. Magnets both attract and repel. After setting a Fibonacci retracement set on a weekly chart, for instance, change periodicity down to daily, hourly, 5 minutes in order to mine for information about the strength of supply and demand.

8 VERTICAL BANNERS Select Fibonacci Retracements from the Title Bar icon: Click on Snap to Point if you want to make sure you capture the highest high and the lowest low. Feel free to experiment with other ratios. Changing them is a breeze! Type your favorite value in the Percentage Value box and click Add. Or, select one of existing levels which you no longer like and click Remove. While at it, you might like to change the colors of a Fibonacci retracement set. It comes in handy when plotting multiple sets of retracements.

9 Thomson Reuters Eikon charts plot the labels of the Fibonacci retracements to the left. If their position interferes with your chart reading, just drag them to the right where you see fit.

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