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Thursday, December 21, 2006

Stock Market Trading - Fibonacci Retracements

A little history, before we go deep into this topic.

Leonardo of Pisa, nicknamed, Fibonacci was one of the best known mathematicians of his time. His greatest find was Fibonacci series.

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, ...

This sequence is constructed by choosing the first two numbers (the "seeds" of the sequence) then assigning the rest by the rule that each number be the sum of the two preceding numbers. This simple rule generates a sequence of numbers having many surprising properties, of which we list but a few.

Take any three adjacent numbers in the sequence, square the middle number, multiply the first and third numbers. The difference between these two results is always 1.

Take any four adjacent numbers in the sequence. Multiply the outside ones. Multiply the inside ones. The first product will be either one more or one less than the second.

The sum of any ten adjacent numbers equals 11 times the seventh one of the ten. Mesoamericans thought the numbers 7 and 11 were special.

What can we get out of these numbers. Try picking any number and divide it by the next number in the series and see what you get.

For example: 21/34 = 0.6176 or 34/55 = 0.6182 or 144/233 = 0.6180
Or the 62% retracement level. Similarly, if you take the previous number and divide it by the next number you get another important retracement level 38%.

For example: 21/55 = 0.382 or 34/89 = 0.382

And you can go on like this. But the most important retracement levels are 38% and 62%. On our site we have Fibonacci numbers calculated for every stock, but it is more than just these two %ages. And includes other key levels such as 50% and others.

Let us take Toll, Toll Brothers, a very HOT stock these days from the Real estate Industry. Let us dissect the chart.

We consider the Low in January, around $32 and a high of $45(approx) around early March. The Difference here is $13. Let us do the calculations using the above numbers.

38% retracement level would be, $13*0.38 = $5(approx).
50% retracement level would be, $13*0.5 = $6.5.
62% retracement level would be, $13*0.62 = $8(approx).

Now let us use these retracement levels to see how the stock behaved after 1st March.
When it was going down, it stopped nearly around $37-$38 mark, which is about 62% retracement level. Note, how the stock held this level and recovered nicely after this.
On its course to recovery, it faced slight resistance around the 50% retracement level, around $40($45-$5).

Once it blew past this level, the next level was the 0% or the last known upper resistance price. In this case, $45.

Now, this is a very good example of 62% level, once again. See how the stock stopped its upward run just around $53. Guess what. $53 is nothing but the 62% retracement level(on the upside). $45+$8.

Finally, the stock faced resistance at the 100% level. $45+$13 = $58. And it held support at the 62% retracement level.
62% retracement level would be, $13*0.62 = $8(approx).

So to conclude, Fibonacci numbers are a real find that if used properly can guide you to better targets. These numbers prove really helpful to judge the upside and downside targets.

Earlier Articles:

Technical Analysis & Decision Making . . . . Support/Resistance Level and It's importance . . . . Trading System . . . . BreaOuts & BreakDowns of Stocks . . . . MACD Indicators . . . . Crossovers-Bullish & Bearish . . . . Stock volume & It's Importance


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