Fibonacci Analysis Read online

  Moving along a little faster than the examples in Chapter 2, the weekly Australian SP/ASX 200 now has three ranges defined. The first range is from near the 6,823 high to level a. The second range is from 6,823 to level b. The third is from 6,823 to level c. Both b and c start upswings within the rally. I do take into consideration the spread between the endings of these zones. If it is very close, don’t bother. Remember confluence is made from different Fibonacci ratios. If the ranges selected are similar, they don’t give any new information. As the three ranges are subdivided, a confluence zone is revealed near 5,691. If you look closely, the bar after (that was marked as point a in Figure 5.2) the capitulation key reversal held this confluence zone. Therefore, this area within this market is extremely important and the key reversal price bar into the actual swing low is not of interest. You will find a void of Fibonacci ratios under this confluence zone explaining why the market ripped down and then back upwards to the next zone forming under 5,958. Remember, confluence zones are formed when different Fibonacci ratios cluster together. The zone near 5,691 comprises a 50 percent and 61.8 percent retracement obtained from different ranges. The price level at 5,958 is not the cap of a zone, only a level of minor resistance. The zone itself falls just under the 5,958 labeled level. Market character between zones will be discussed in more detail in Chapter 6.

  Oscillators can be useful as the price lows selected for range endings often align with indicators holding their moving averages or testing crossover formations within the averages on their respective oscillators. In Figure 5.3, a comparison should be made between the price lows and oscillator positions aligned with lines a1, b1, and c1. The oscillator position at a2, relative to the low at level a, has added significance because the Composite Index is warning that the RSI is failing to detect a market reversal when RSI fails to diverge with prices. The Composite Index then pulls back to test where its simple moving averages are crossing upwards to become positive at point a3. These subtleties are tremendously important, as they are the guides allowing you to adjust for any market expansion or contraction changes developing within your data.

  A fourth range is added to the weekly Australian SP/ASX 200 chart in Figure 5.4. The new range has a new 38.2 percent retracement that falls within the same confluence zone near 5,691 (m). This repeating overlap of different Fibonacci ratios in the same area of the chart confirms this area within the chart is major support and is of great importance to this market. All future price swing projections will be made using this hidden confluence zone that is well above the actual price low that occurs at price low x.

  FIGURE 5.3 Australian SP/ASX 200—Weekly Chart

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

  FIGURE 5.4 Astralian SP/ASX 200—Weekly Chart

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

  We can confirm that the market is using the confluence zone at m to develop future price swings in the following manner. In Figure 5.5, a box is used to measure the range between zones ap and bm. The box is empty and has no significance to its width, only its height, ab. I use boxes because they are easy to see. Next, draw a box with the same height directly over the first. Then, drag the new box up so its bottom sits on the top of the first box. The new box is shaded a light gray, and the height at cd is the exact market top before the hard break to the right of d. The market clearly shows respect to this geometric measurement we have made, and it would have been off if we had used the price high. This is how you know to truncate the spike to start all the ranges. Eventually, you will see everything aligns but is off the same amount as the spike you did not truncate. Over time and with experience, you will know right away where to start.

  This is the smallest box I would use in this weekly chart. It is of interest that price low a and price high d show the Composite Index oscillator using its moving averages (simple 13 and 33 period averages) as support into a1 and resistance at the same amplitude level into d1. The RSI is not as clear.

  As the market respected the first box projected from confluence zone m, you need to use a larger swing because you have lots of price data under the range of the first box drawn. The next box is drawn from the end of one of the selected ranges up to zone fm. No matter what price swing low you start from, you will end the box at the confluence zone defined in the first steps. That is why you have to know support in order to define future levels of resistance. At this stage, you are still developing a geometric grid within existing price data. When I draw a second box with height ef and project it from confluence zone fm, I discover the top of the new box at point h has again been respected by this market as a top forms. This is so major a find that you can view the confluence zone at m as the midpoint of this market’s developing rally until it is broken by a larger degree decline. I am working from a real-time chart and will make the next price projection, which will be into the future for this market.

  FIGURE 5.5 Australian SP/ASX 200—Future Price Swings Using a Proportional Projection

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

  FIGURE 5.6 Australian SP/ASX 200—Finding the Significant Confluence Zone

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

  Figure 5.7 remains the weekly chart for the Australian SP/ASX 200 Index. The first steps to creating a future price projection have been completed by building a confident view the confluence zone at m is significant. Now, you draw an empty box the height jk. You used point j to define the ending price level for one of the larger ranges we needed to subdivide earlier. Now, you will use it again to take a measurement to the confluence zone. Move the box up to confluence zone, m. The top of the new box projects a market swing price level into the future. The price is 7,478. It is a single target and not confluence by itself. As the market topped near the 6,801 price level, 7,478 is a good distance away. So subdivide the box, mn, using a Fibonacci retracement tool. When this is done, you will find the market high is currently reacting to the exact 38.2 percent retracement within the new box, mn. This happens all the time that a future price target like n produces retracements showing respect to the existing data. It is how you can project more than one future swing. In this market, it is expanding, and you used the zone m to project and create all proportional measurements. If you are working with a contracting market, the zone that will prove key for all your measurements will fall short of an actual price swing. One fast way to find this area is to look for the strongest part of the move. Then when you create your confluence zones, you use the confluence zone that falls closest to the middle of the strongest swing.

  If you know the Elliott Wave Principle, use third waves to your advantage. You will have an added advantage if you look for a fourth wave that falls into the vicinity of a previous fourth wave in an extending move. Mirroring fourth waves often give the midpoint away within these extending moves. You know you can add, subtract, multiply, and divide Fibonacci ratios to identify additional Fibonacci ratios, but people do not know how to apply this knowledge. Now you are finding this market is developing a proportional grid that is undeniably mathematical in its construction. Trade the markets that form such grids and avoid the markets trapped in mathematical noise. This grid work of confluence zones behind the price data is always present regardless of the market or time horizon.

  Some markets are very thin and look like Swiss cheese with holes throughout the data such as esoteric currency crosses. Markets with this style of data can be converted into line charts first. Then use the line chart to calculate the confluence zones. If your market display preference is candlesticks, use the real bodies only to start and end a price range to create the grid structure. The real bodies in candles are very useful, but their limitation is there is too little data to view at one time along the x-axis. So keep this in mind and do not use large candles, but compress them as much as possible. Point-and-fi
gure charts offer many visual cues to create a support and resistance grid using Fibonacci ratios. Truncate the isolated reversals and use the dominant blocks within the point-and-figure data. The confluence zones are accurate but the point-and-figure diagram has no x-axis for time analysis. Therefore, I prefer not to use this style of charting. Grids form in all price data character, except triangles and termination wedges. I will address triangles in the next chapter. It is not necessary to look for markets in stellar trends as you have the tools now to manage volatile market swings in any market.

  FIGURE 5.7 Australian SP/ASX 200—Creating a Future Price Projection

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

  In Figure 5.7, you can further subdivide the top box from n down to the first Fibonacci level at the 38.2 percent retracement near 6,801 to find other levels of minor resistance above the current market. I prefer to create additional boxes through the price data below j up to confluence zone m and then further subdivide them into simple Fibonacci ratios of 38.2 percent, 50 percent, and 61.8 percent. Soon you will find the confluence zone for future swings as the new boxes projected from m will be higher as the range is larger, but their proportional Fibonacci subdivisions will soon overlap at future confluence zones. My suspicions would be that a major confluence zone falls very close to the 7,478 level in this chart making it a major target within this developing rally.

  We spent considerable time using Fibonacci analysis to project future price highs in a developing market rally. Most traders do not know how to project targets into the future except by Fibonacci expansion swings. When using a Fibonacci expansion tool, you need to change the default settings so proportional targets of 61.8, 100, 138.2, 150, and 161.8 percent are also determined. You will find the 138.2 and 150 ratios invaluable for revealing confluence zones. You will take a closer look at Fibonacci expansion swings in Chapter 6 and develop ways to account for expansion and contraction phases within a market.

  The concept of confluence zones should be clearer to you now, and you should be able to see how markets develop mathematical grids within the price structure. When these skills come easily for you, and it does take practice and time, you will see the market confirming your efforts in any time horizon you elect to evaluate.

  Once you are competent with the horizontal axis you can consider the diagonal and vertical axes within any chart. Don’t jump to these axes immediately until the horizontal is very clear to you. It will be a mistake, as horizontal zones define the risk-to-reward ratios you need to control your capital drawdown exposure. The biggest problem I find with traders who attend my seminars is they take on too much all at once when they return home. Focus on one axis at a time and one new method at a time.

  Many traders do not use the diagonal or vertical axes effectively. Traders often draw trend lines connecting price lows or highs, but much more can be accomplished.

  One method is to create Fibonacci channels. Figure 5.8 remains the Australian SP/ASX 200 index, but it has been changed to a shorter time interval of 3-days. I like a 3-day chart as it filters some of the noise in a daily chart and is faster than the majority who can only display weekly intervals. The reason you may see unusual display periods for creating my charts is the knowledge of knowing time ratios are significant. They help my indicators. I also use three moving averages with a fixed period interval because they provide a fast Gann target estimate. Therefore, I adjust time within my charts and not the period interval of my averages. If you can only see conventional time periods, analyze charts in a 4 : 1 ratio. In other words, a monthly chart against the weekly, a 60-minute chart against the 15-minute chart as another example. Entry and exit signals forming in these two time periods serve to filter out false signals in oscillators. The confluence zones in the larger time interval chart are major targets for the developing subsets within the shorter time period. Use oscillators only when the market reaches confluence target zones. Just these changes alone can dramatically change the probable outcome of a trade and your annual return.

  In Figure 5.8, we created a parallel channel by looking at market pivots that test confluence zones on the horizontal axis. Also, all the Fibonacci grids have been removed, but not until horizontal lines were drawn across the screen to permanently record the price levels and confluence zone widths that were defined from earlier steps. The zones in Figure 5.8 have been further adjusted by using a transparency feature, so they appear as soft bands of gray running horizontally in the background behind the data and do not interfere with any analysis of the price data itself. There is no need of all the individual lines that form when using multiple Fibonacci retracements. Keep only the confluence zones themselves. The horizontal line on the top right of Figure 5.8 is the future price target that was developed from Figure 5.7. The zone most important for this market is at m. (Using a different color for this one zone on your computer may be helpful.)

  FIGURE 5.8 Australian SP/ASX 200—3-Day Chart

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

  Using points x, y, and z creates a channel. All three levels selected at points x, y, and z have shown respect to the confluence zones within the horizontal axis. It is very important to see that we are continuing to build from the zones defined in prior discussions.

  Parallel channels are then projected in Fibonacci relationships relative to the width of the first channel defined. Each trend line above the channel has a Fibonacci relationship to the first range. In this chart, we see the recent price high has failed at one of the projected trend lines. In Figure 5.8, the Fibonacci ratios used in this chart are 61.8, 100 (equality to the width of the channel), 161.8, and 2.618 percent. The SP/ASX 200 failed at the 161.8 percent channel line (point t) relative to the channel width developed from the Fibonacci horizontal confluence zones. Like the Roman Colosseum diagram, this market is respecting Fibonacci ratios along two axes.

  When the width of the first channel was being considered, the oscillators were examined. Point y has the Composite Index at a resistance level at point a. Point z not only tests major support, but also marks divergence between the Composite and RSI at a level that has been significant in the past. (Trace back the horizontal line drawn on the indicators.) Box e within the oscillators shows the indicators falling to the horizontal lines c and d. Another swing up will occur, and the danger point will be a swing pushing the oscillator to the underside of the averages crossing over towards a negative spread (within the box). The character of the indicator is significant and we should expect to see W patterns in the oscillator duplicate themselves at future times. This observation will help your timing.

  Cycle Analysis

  Time is without question the most important axis within our charts, but without price analysis skills, time analysis is useless.

  The tools and methods to analyze time fall into three primary categories. The most common are fixed-interval cycles, in which traders try to find the best-fit interval to connect market lows. Because markets expand and contract in price and time axes, this method has limited success if you are looking for timing consistency that offers value for precise market entries and exits. Fixed-interval cycles of long and short periods will form their own confluence zones by creating cycle lows within a short period on the x-axis. Multiple cycle lows are an improvement, but even then, they are better used as an analysis tool, as the actual market timing to reverse in price can be significantly off for trading purposes.

  A second method becoming more acceptable is to study astronomy and not fixed time cycles of any kind. In Figure 5.9, the 3-day Australian SP/ASX 200 chart shows vertical lines. As soon as someone sees astrological symbols, they assume this to be astrology. This has no relationship to personal natal chart reading or progression analysis. Astronomy is a science, and astrology is not. The ancient Babylonians studied the motions of the stars centuries before anything like a system of astrological interpretation developed. Astronomy is th
e scientific analysis of the planets, asteroids, and the Sun and Moon regarding position, angle, speed, retrograde movement, and much more. Astrological confluence to define high probable inflection points in markets works very well. If this is an area of interest to you, look into the analysis methods of W.D. Gann, who called this area of study the Natural Laws of Vibration. Gann had a marketing problem in his day, too, and never used the word astronomy.

  The chart in Figure 5.9 is showing you how astronomy can help us time markets. In Figure 4.7, the last diagram in Chapter 4, the illustration showed how the sacred geometry figures form from within the nautilus shell spiral. The pentagram is loaded with Fibonacci ratios and many of the astronomical aspects that create the sacred geometry patterns contain the Fibonacci ratios of 0.618 and 1.618. It may seem unthinkable to you now, but NASA’s website could become one of your best friends for market timing. The vertical bars in Figure 5.9 mark when Mars and the Sun are within sixty degrees of separation and they are no more than +/-2 degrees apart. The width of the band will vary before they separate and exceed the +/-2 degrees criteria. When this condition of separation is realized by two degrees or less, we say the planets, in this case Mars and the Sun, are in orb. This cycle requires geocentric mapping where the Sun is viewed as an orbiting body around the Earth at the center. Even in this chart, it is easy to demonstrate the cycle is not a fixed-period interval between each aspect hit. Box ab, having to mark the diagonals of the box so the price data would not be hidden, was copied and moved to create box cd. This allows your eye to see that the next cycle is not of equal spacing to the first. Some cycle intervals are shorter and some have even longer spacing than box cd. This is the character of a natural cycle because of the elliptic orbital path of the planets around Earth. Cycles are not symmetrical and this method of analysis is worth the effort to learn.