Fibonacci Analysis Read online

  FIGURE 2.13 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  As a trader, you now want to know where the market should not go, so that you know where to put your stops if the rally continues higher than your confluence target zone at $44. The rally that develops and stops dead on the line at c is no accident. Only look at your indicators as the market comes into the target confluence zone. You will learn the market respects these confluence zones that form from ranges ending at strong internal bars, in every time horizon. Later as this method is developed further, we’ll look at international global indexes to see how global strategies can be built with this analysis. But we need to stay with the basics for now.

  We know where the market is going once A has been established. The market will target the confluence zone at c. Now we want to determine where the market should not go. To answer this question, we need a third range and the question to ask, is the pivot at Q1 the right one to use or should you stick with the theme here and go straight up to Q2, to the strongest bar where the meltdown begins with conviction?

  In Figure 2.14, I have temporarily removed the last range I added in Figure 2.13 so you can easily see the third range selected and why. Again you start the range from the same pivot low and end the range at the price high that falls between $55 and $56. Study the internal ratios that fall on the 61.8 percent, 50 percent, and 38.2 percent. You will find not a single price bar respects these levels. If the market does not respect the range you picked, it is not the grid the market is using to build its future swings so don’t stay with it.

  In Figure 2.15, the range has been adjusted so the new high aligns with the bar that starts this meltdown. I do not mean the bar that starts the trend, but the strong bar that is the world’s point of recognition that the market is falling like a rock. In this price bar, we see prices fall from just over $56 to less than $53. Price points m, n, o, p, and q are the bars I pay attention to. My eye always travels from right to left looking at the more recent data and scanning back. These points all confirm the market is working off these proportions in some manner. In Figure 2.15, a range that was developed in Figure 2.14 was removed so you could see the details. Now the missing range needs to be redrawn so you have the full picture.

  FIGURE 2.14 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  FIGURE 2.15 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  Figure 2.16 shows all three ranges and their subdivisions in the 3-day Centex chart. The confluence zone marked x1 was the target to sell that was identified from the first two ranges. When a third range was added, a new confluence price zone forms at x2. We are armed with a lot of information right now. We know the target to reenter the market for another swing down is at confluence zone x1. We know the single line that formed just over this zone near $45 that is a 61.8 percent ratio from the first range selected is of less interest to us or to the market. We know the next confluence zone at x2, where a 50 percent and 38.2 percent ratio nearly overlap, is the price zone the market should not exceed. As a result, we know where to put our stop, which is just over the confluence zone x2. Since we have an entry and we have a precise exit level where we know we are wrong, we know what our risk-to-reward ratio will be. If we believe all trades should have at minimum a 1 : 3 risk-to-reward ratio, we would see we are risking a tad more than $2. Better to enter near $44 and exit just past $46. (When you enter stops, never use an even number in any market.) To keep a 1 : 3 risk-to-reward ratio, the market must move $6 away from $44. In Figure 2.16, this occurred, but we made the projection before the trade was established. To those who believe Fibonacci ratios are of little value; let them continue to do so, as those of us who work to develop these concepts will see bankable results.

  FIGURE 2.16 Centex 3-Day Chart—Two Fibonacci Confluence Zones

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  In this major decline of Centex, we did not discuss how to develop targets for the meltdown. We covered how to create entry levels and stop placement, but methods to determine price targets for future swings must follow in the next discussion. I have not forgotten to answer the question, how do you make money from a spiral that turns round and round when you have to use two-dimensional charts? The geometry will be discussed in Chapter 4, and then developed further in the final chapters. The nautilus shell is in fact the most sophisticated geometric model you will encounter, as it has implications to traders in both the x and y-axes impacting both price and time analysis.

  CHAPTER NOTES

  1 Cooper, 1130-1132. See Plato Republic 509d-513e.

  2 Cooper, 1224. Plato’s Second Principle, known as the Indefinite Dyad, is sometimes called the Greater and the Lesser, and its relation to the golden section, φ. Socrates and Timaeus banter the importance of these relationships in Plato’s work Timaeus using complex triangles. Timaeus shows how geometric form was used to argue logic. All of the Pythagorean symbols have important meanings tied to the arrangement and proportions within the geometric forms known as sacred geometry.

  Given the facts above, Plato revealed the Pythagorean belief that these relationships connected all:Greater × Lesser = 1

  Greater - Lesser = 1

  Greater ÷ Unity = φ

  Unity ÷ Lesser = φ

  Greater ÷ Lesser = φ2

  3 CQG traders, in particular, will have difficulties. Change your default as described on page 21.

  4 The W.D. Gann Stock Trading Course Collection.

  5 Cooper.

  CHAPTER 3

  Support, Resistance, and Price Projections

  IN THE LAST DISCUSSION, Figure 2.16 defined two Fibonacci confluence zones that formed within the 3-day Centex Corporation chart. Our purpose for defining these target confluence zones was to enter a short position in a developing trend. The intraday charts showed the market should not exceed the zone above, and we knew therefore to place stops over the next target zone. Stops are not within the zone, but just above the zone. Longer-horizon traders would have made the same calculations but might have needed to consider their stop exit level above one zone higher again. In Figure 2.16, we did not create the third confluence zone, but we will do so as these examples unfold.

  As we know where to sell and where to put our stop, we need to know now where the market is going to complete a risk-to-reward ratio for our risk management needs and position size determination.

  The two confluence zones derived from different Fibonacci ratios created in Figure 2.16 are seen passing through point a in Figure 3.1 and extend across the chart. On the far left, the ranges used to create these zones are still visible. They have dots on the calculations. They can be deleted once a horizontal line has been added to mark the two confluence zones at 45.56 and 43.97, as they are not needed any longer. Both charts show the 3-day Centex Corporation data but Figure 3.1 now shows the market decline that formed after the short position entry at point a.

  FIGURE 3.1 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  The question to answer was, how do we determine the price target if we sell into point a? The easiest method is to draw a box marking the range from the higher confluence zone at $45.56 to the market high in this chart. A box is used just to measure the range. So the width of the box has no meaning in this application, just its height. I draw a second box over the first and drag the second box, being careful not to change its dimensions, to a position that starts at $45.56 and mirrors the first range. The range of the box ends at $12.26. That is a target too far away from the entry level at $43.97. (The price is on the left of the zone’s horizontal line.) As I know I can add, subtract, divide, and multiply ratios, I elected to subdivide the new box with a Fibonacci retracement tool to dete
rmine the 38.2, 50.0, and 61.8 percent ratios within the box. A rational target in my comfort zone is the first level at $32.84. From this single projection, I do not know if my target will be minor or major support. I do not know what probability to give this target either. While it is a valid target, I have other ways to accomplish this task that experience has shown is better. This method is very useful for the Elliott Wave-challenged trader. There is no wave counting involved. Just a simple use of mirror geometry and you have a good start when your indicators confirm.

  At price lows 1, 2, and 3, the market is respecting the zone created at $45.56 that was used to create the equality mirrored swing using the boxes. There is a reason this works and I’ll defer that discussion until the next chapter. Our focus will remain on the methods used to create the price targets.

  If the market reaches price low 3, you may find a bounce that your indicators warn will lead to further losses. If you know the Elliott Wave Principle, it is easier because you would see an incomplete wave structure in the decline into the low at point 3. Momentum oscillators would also warn a final bottom is not in place. Whatever method you use, there is a big spread from the 61.8 percent line that runs through price low 3 and the bottom of the box at $12.15. So subdivide the last range from the 61.8 percent ratio at $24.98 and $12.15. (You will find $25.09 in the chart, as the tools used were deliberately spaced different so you could see them. This is also true for $12.15 and $12.26 that end ranges.) This decline is incomplete but a bounce will form.

  How do I know a bounce will develop? My indicators are used only when the market reaches a target zone. The indicators then give me permission to develop a trade strategy or warn when my exit plan should be followed immediately. Part of the exit plan might be to unwind a portion of the trade and add that portion plus x percent into the bounce. By focusing on momentum indicators only at the zone, this method filters out premature and false signals. I will look at oscillators again in Chapter 5.

  How do I know how high the bounce will go? I repeat the process all over again by starting from a price low to calculate resistance levels and take subsequent price bar highs that started a strong thrust down within the decline.

  But how can I be confident this is the price support level the market will respect for a significant rebound? From this simple method alone, I cannot answer this latter question. For this reason, we need to continue.

  In the chart in Figure 3.2, you are going to use more of the information and observations we developed in Chapter 2. In Figure 3.2, you see the same box from the high to the zone at $45.56. But flipping the box down to produce a mirrored target overlooked two important facts about this data set. The first thing never considered was the gap near $58.18. If you page back to Figure 2.10, you will see a specific measurement was taken because the gap was in this chart. The other fact not considered was the price low, A, in Figure 2.10. We talked about why that price low was used rather than the key reversal swing down that followed shortly after this move. We discussed how the probability, and hence our confidence of being right, was confirmed when the market showed respect to the results in hindsight within Figure 2.11. Plus we cannot overlook an important point . . . we were right! When studying Figure 2.11, we found the market failed after a corrective rally into the 50 percent retracement. All this information is evidence why this market is declining. In the example for Figure 2.11, we had not discussed confluence zones, but price low B in Figure 2.12 is a major factor in what we are considering now.

  In Figure 3.2, you see the confluence zone at $43.97 from the work in Chapter 2 in Figure 2.13. The market is saying this price low is one of the key levels it is using to build future price swings. We have to use it. The upper box dimensions in Figure 3.2 are the same as Figure 3.1, but now we are going to project the box down from the lower confluence zone at $43.97 that we know is a major marker for this market. The spacing between the two boxes, or confluence zones, is the same width as the gap. No surprise, as often markets use the gaps as measuring features elsewhere within a chart. By knowing we gave consideration to the gap and the key level at $43.97, we know we have built upon the earlier knowledge the market gave us. Our targets will be more accurate, though we need to define confluence zones to identify the difference between major and minor support targets.

  FIGURE 3.2 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  In Figure 3.2, the market has fallen to a level at $18.52 that allows us to consider another proportional subdivision of the lower box. The lower box was subdivided into 38.2 percent, 50 percent, and 68.2 percent ratios, and the prices are at $31.41, $27.53, and $23.65 respectively. In Figure 3.2, we also created a box between the 38.2 percent line at $31.41 and the current price at $18.52. When this smaller box is subdivided, we discover a confluence zone where an overlap forms at 23.52-23.65. This confluence zone is marked c1 and will prove to be important. All other lines in box a from $31.41 will be secondary. Why? The other Fibonacci ratios all stand alone.

  The next chart in this series of 3-day Centex Corporation price projections is Figure 3.3. This chart shows several ranges subdivided, and additional confluence zones at $18.52 and $15.76. Draw a horizontal line at any confluence zone. The reason is found in Figure 3.4.

  The reason you want to draw horizontal lines through the confluence zones, in some cases marking the highs and lows of the range itself, is you can delete all the other details from your screen. Most of the Fibonacci lines and boxes are deleted leaving a clean screen in Figure 3.4. Now other methods will use these confluence levels that we will discuss at another time.

  At the start of Chapter 2, we reviewed the terms and methods to create ratios, mean values, and proportions. Some of the secondary subdivisions in Figure 3.3 use proportional measurements. The Fibonacci ratios subdividing a range are in every example, but the mean has not been used. In Figure 3.5, we need to stay with the same time horizon and stock to allow these next concepts to be clear. We are going to use two facts from our earlier work to develop a different way of making a price projection for Centex Corporation.

  FIGURE 3.3 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  FIGURE 3.4 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  FIGURE 3.5 Centex 3-Day Chart

  Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software

  We know the gap near $58.18 is important. We also know gaps often form 50 percent subdivisional lines within the developing price geometry. You will use these facts now to your advantage. Define a box from the middle of the gap to the price high. This first box is marked d in Figure 3.5. That will become your arithmetic mean within a proportional equation that you need not write as a formula to understand.

  Copy the box and create a mirrored placement under the first box. The new box in the middle of the chart is marked e. Within box e, you will subdivide the height of this box into the Fibonacci ratios. Take notice of the ratio that forms at price $44.01. All the old ranges that defined the two confluence zones in Chapter 2 are visible in this chart. The confluence zone at $43.97 that crosses the critical pivot at price low B has just been confirmed again. You are using different methods, and finding the price low at B and the midpoint of the gap continues to anchor key measurements. This is exactly what is meant when I said the market forms milestones that tell what key levels are being used to form future swings. All these calculation are derived from the market decline without benefit of the market data that formed in the rally. The reason for not showing the data in the rally is to learn how to do this when it is hard because new price lows are developing. The same methods apply when the market is breaking into historic new price highs. We will look at that scenario, as it is fitting for China, India, Australia, and many of the equity markets being dragged up by these indexes. B
ut this 3-day Centex chart is building the skills you need to tackle the tough international scene we will discuss later.

  Figure 3.6 is the third box in the series. Move a copy of the first or second box down to the bottom of the second box in the Centex Corporation data. You will again subdivide the range in the third and lowest box. Level e, or the 50 percent line, is respected by a small bounce up before the market works its way lower. Level d is also respected as resistance if you trace line d back to the left to pivot d1. Price level c shows how the market will use the Fibonacci ratios at c2 as support, and c1 as resistance. (In Figure 2.12, c2 is level B.) The math would look ugly, but the geometric visuals are very easy to use and read. This is why Plato used geometry to explain the ratio that binds all things together and not the Fibonacci numbers that produce irrational numbers.