Fibonacci Studies (Arcs, Fans, Retracements & Time)
Leonardo Fibonacci (1170-1250) was an Italian mathematician credited with the discovery of a series of numbers now known as Fibonacci numbers. Fibonacci numbers are a set of integers where each number is the sum of the two preceding numbers (1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144,). They have a couple of additional intriguing characteristics: each number is about 1.618 times greater than the one before it (such as 5 / 3) and approximately 0.618 times smaller than the following number (such as 5 / 8).
The ratio 0.618 is one of three important Fibonacci ratios that play significant roles in technical analysis. The others are the ratio between the second set of two numbers, 1 / 2 or 0.5. And, the third is the ratio of every alternate number, or 0.382 (such as 5 / 13).
When you look at these ratios in the form of percentages, the three most important Fibonacci levels become 38.2%, which is commonly rounded down to 38%, 50% and 61.8%, which is commonly rounded up to 62%.
Fibonacci numbers form the foundation for a number of technical indicators, including Fibonacci Retracements, Fibonacci Arcs and Fibonacci Time Zones.
When a price is trending upward or downward for an extended period of time, it's common for prices to undergo a retracement, or move in the opposite direction, before continuing along the previous trend. For example, if a stock's price increases from $6 to $12 and slipped 50%, this retracement would take it to $9 before it continued along its upward trajectory.
Analysts have observed that the Fibonacci levels commonly act as support and resistance levels for prices as they trend and can be helpful for predicting where prices are likely to retrace during an up- or downtrend. Significant price changes are expected to occur at the Fibonacci levels.
In order to use Fibonacci Retracements, observe the following guidelines:
- If a security is experiencing a strong up- or downtrend, draw horizontal lines extending through the trough and the peak on the price chart.
- Draw three additional horizontal lines at the Fibonacci levels of 38%, 50% and 62%. After a significant price movement up or down, the new support and resistance levels are often at or near these lines.
Fibonacci Arcs help anticipate support and resistance levels and establish price targets.
Fibonacci Arcs are created on a price chart by placing the center of each arc on the last peak or trough of a trend line to show potential support and resistance lines. Each arc intersects the original trend line at each of the Fibonacci levels drawn as horizontal lines at 38%, 50% and 62%, just as with Fibonacci Retracements. Fibonacci Arcs are typically charted on the same price chart as Fibonacci Retracements, though they can be drawn separately.
Fibonacci Time Zones
Also known as Fibonacci Time Series, Fibonacci Time Zones are used to predict price reversals and changes in trends.
A set of vertical lines, Fibonacci Time Zones are plotted on a price chart using the Fibonacci number sequence: 1, 1, 2, 3, 5, 8, 13, 21, 34, etc.
Fibonacci Time Zones are most commonly used for studying price action on longer time frames. By placing the initial line at an extreme point on the chart, the investor can then monitor price action near the vertical line representing Fibonacci numbers for significant stock movement.
To begin plotting the intervals, you must first select the time frame you're working with and create the Fibonacci lines at appropriately spaced intervals. As prices trend, analysts have noticed that alterations of the trend will occur on or around the Fibonacci Time Series levels.
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.