Fibonacci Analysis Read online

  FIGURE 5.9 Australian SP/ASX 200—3-Day Chart

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

  Before we move away from Figure 5.9 to look at Fibonacci time cycles, study the Fibonacci diagonal channels in this chart. The upper gray channel is the original diagonal defined, connecting the tops at astrological time targets. The width of this channel forms the basis for projecting the Fibonacci parallel lines under the market. You will find price low e bottomed on the 261.8 diagonal ratio. As you scan the chart from right to left, observe the places where price respects the confluence zone created in the horizontal axis and bisects a Fibonacci channel in the diagonal. On several occasions, the intersection offers a good entry, but stops must be outside of confluence zones and never within the bandwidth. Long-horizon traders need to carry stops one zone away or possibly two depending on how the grid develops and the market’s volatility. We will delve into this topic more in the next chapter.

  We have considered fixed-period cycles and astronomical cycles that we know have Fibonacci relationships within the calendar intervals that create the sacred geometry forms from planetary aspects and retrograde cycles. Now, we will look at Fibonacci cycles along the horizontal axis.

  The chart in Figure 5.10 remains the 3-day data for the Australian SP/ASX 200. The vertical lines are Fibonacci time cycles. The spacing is a growth cycle that is 161.8 percent greater than the spread of the prior two cycles. The chart seems to have a few valid price reversals at points a and b. But the cycle interval that falls at point c is neither on the low of the downswing or on the start of the new rally. This is the weakness of using Fibonacci cycles as a trading tool. They are better viewed as an analysis tool than as a guide for timing trade entry and exit.

  FIGURE 5.10 Australian SP/ASX 200—Fibonacci Time Cycles

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

  Many traders wonder if the global traders who have rapid access to these technical tools on computers actually reduce the effectiveness of these tools. In my library, I have a rare daily chart book that was in a private collection and printed in 1932 with permission of Barron’s and the Wall Street Journal. Using the daily data from 1897 of the Dow Jones Rails and Industrials indexes, I know computers or easy-access communications by market participants does not contaminate the data. This is just an interesting example as I have made a more thorough study of all my technical tools and methods from the 1800s. (It is interesting to note a major freefall in the American equity market developed into 1903, similarly as the Nasdaq experienced in this twenty-first century nearly an exact 100 years later.)

  The data in the Dow Jones 1897 Rails and Industrials chart (Figure 5.11) show a Fibonacci cycle added to this historical data. If I move the entire cycle series from the price low at a to a later start date when the rally begins at point b, the price high in Rails will align exactly. This is interesting as you do this when you define ranges for Fibonacci retracements. But the problem that results is the market does not respect any other pivots within the cycle’s series. A modern-day technical tool applied to the 1897 Rails and Industrials indexes is no better than the chart we considered in Figure 5.10. Clearly, computers have made no impact on this cycle tool if you saw the conclusive results through the entire database. But even when confluence zones are developed using just the Fibonacci cycle tool, the results in my opinion are poor. But before discarding Fibonacci cycles as a tool to help with time analysis, you might consider a different application.

  Conventional Fibonacci cycle tools are created from a single starting point. No one can use or read the first few projections as they are too close forming a band of noise. Consider Figures 5.8 and 5.9. Define a starting range between pivots and calculate the Fibonacci cycle as a series derived from the selected range. This is the same concept as described in Figures 5.8 and 5.9 for a diagonal axis projection. The method applied to the vertical axis is better than current Fibonacci time cycle convention.

  If I were to ask you, “Name the year when the greatest number of banks and business failures occurred in the financial history of the United States,” I bet you would answer, “a period within the Great Depression.” It used to be my answer, too, until I encountered the following:. . . contraction of the currency began to be felt (as large quantities of currency left the country), multitudes of banks and individuals were broken. The panic (that followed) caused the failure of nine-tenths of all the merchants in this country . . . Two-thirds of the real estate passed from the hands of the owners to their creditors.1

  FIGURE 5.11 1897 Dow Jones Rails and Industrials Chart

  Source: Private Publication by Robert Rhea that was printed by Permission of Dow, Jones & Co. Inc 1931

  This is not a description of events during the Great Depression. It is the financial collapse that occurred in 1819 as a result of the War of 1812.

  The Great Depression did not end in the United States until manufacturing had to ramp up production for World War II. But nearly one hundred years earlier than the Great Depression, in May 1837, a liquidity crisis caused the suspension of all the banks in the country. Samuel Benner’s 1884 book called, Benner’s Prophecies of Future Ups and Downs in Prices, is credited as the first book that provided market analysis and future cycle predictions. Benner states, “This year of reaction makes the second year in our panic cycles, and is eighteen years from 1819.”2 The panic peak, however, did not come until the Fibonacci cycle year of twenty-one years from 1819. Interestingly, the actual peak is a Fibonacci number. Benner’s book discusses panic cycles for wheat, corn, cotton, hogs, railroad stocks, and iron primarily.

  Think the year of 1819 is the worst year in American history? It was not. In 1883, an even greater number of business failures occurred, based on a total percentage of businesses. There is indeed a cycle under this boom-and-bust macro overview. Benner had collected government data from as far back as 1800 and covered economic cycles of prosperity and contraction for nearly one hundred years. Add this historical period in the United States to data from the 1900s and you have more than two hundred years to evaluate Fibonacci cycles within a macroscale environment. Robert Prechter duplicated Benner’s cycle chart of past economic booms and busts from the 1800s by extending the exact graph of Fibonacci intervals into the 1900s to extend the cycle. It has had some market respect with the decline into the 1987 lows, but it has since added little timing value for traders. Benner’s book forecasted a decline in 1891. He was right. His small book became widely read as additional cycle “busts” were foretold. But when the years arrived, the market failed to respect the targets. It would appear the macro results seem to be as fickle as seen in the shorter applications. Prechter, like Benner a century before, would find the macrocycle slip away.

  Nevertheless, there is a reason for these seemingly fickle results. Fibonacci time cycles are in fact only a subset of a cycle methodology that does not produce a linear series. In other words, not every vertical line in this series should be given equal consideration, or in many cases, the cycle should not be given any consideration. It is not the tool at fault, but the application and understanding of its use. Even Benner in 1884 alluded to this fact. In the latter chapters of this book, we will revisit this discussion.

  Fibonacci Angles

  The final chart in Figure 5.12 utilizes the 3-day Australian SP/ASX 200 to make an extremely important point. Speed lines, Fibonacci angles, and Gann angles all have greater value when projected from a price point intersecting a horizontal Fibonacci confluence zone. In Figure 5.12, a triangle, abc, is highlighted in gray. The bottom is set on a confluence zone. Point a is at the price that respects this confluence zone. You define the angle of the hypotenuse by drawing line ac and extending it so that it ends at the price highs that fell under the top of a box projection in Figure 5.5. By extending the hypotenuse line that defines the triangle, you create the most accurate angle possible. Fibonacci ratios on the horizontal
are always points of interest defining this new technical projection on the diagonal. The range of side bc is now bisected into the 38.2, 50.0 and 61.8 ratios. Fibonacci angles result when the subdivisions along side bc are extended to point a and then forward in time. The middle-angled projection impressively stops the free fall that follows to price low x. Because you are working with proportional angles, a fourth has been added to show how a 161.8 percent projection would appear. It is marked Level 4 and bisects an extension of side bc and extends back to point a. The chart shows the market respected this Fibonacci angle as well at the high that forms to the left of c. A dotted line creates a rectangle by mirroring the triangle abc. It is of interest that the horizontal line across from c and the 161.8 percent angled line bisect at the price high to the left of c. As this is a confluence between the horizontal and diagonal axes, plus a time target based on the sextile aspect of Mars and the Sun on the vertical (see Figure 5.9), you have in essence just entered the analysis field of W.D. Gann. The tools are different, but the objective is not. When price, time, and geometric angles all come together, you have no greater point of confluence within a chart.

  FIGURE 5.12 Australian SP/ASX 200—3-Day Chart—Fibonacci Angles

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

  CHAPTER NOTES

  1 Benner, 97-101

  2 Ibid, 102.

  CHAPTER 6

  Fibonacci Expansion Targets and Confluence in Time

  THE CHART IN FIGURE 3.7 (Chapter 3) introduced the conventional method used by the financial industry for creating Fibonacci expansion targets. Convention says to take the range of a market price swing—for example, a price low to a high—and then project from the following correction low three Fibonacci ratios of the original measured swing. The standard ratios to project are 61.8 percent, 100 percent (equality to the measured move), and 161.8 percent. This method does not allow for market expansion-or-contraction price action within the larger trend. The projected expansion targets also yield a single price level that can neither be identified as major or minor resistance or support. Multiple ranges can be selected and the swings can then create confluence zones, but these still do not allow market expansion or contraction scaling within the data. This method can be less accurate than stringent risk management may allow. Therefore, this chapter will reinforce some of the earlier methods and concepts discussed and then advance the techniques further to improve the probability of conventional application.

  The 10-Year Japanese Government Bond (JGB) has been a leading bellwether for the 10-Year U.S. Treasury Note for several years. In 1998 to 2000, this market developed a time-consuming corrective contracting triangle. Triangles are difficult, and this allows us the opportunity to take you step-by-step through a market that offers perhaps the toughest challenge this methodology experiences.

  FIGURE 6.1 10-Year Japanese Government Bond—2-Month Chart

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

  The chart in Figure 6.1 is a 2-month bar chart for the 10-Year JGB. In the middle of the chart, trend lines delineate where the triangle develops. We recognize this corrective pattern will lead to a thrust upwards, as it is a continuation pattern that will often resume towards the larger trend. The question is, where will the target thrust go above the triangle? The first step will be new to this industry. We are not going to use the dimensions within any part of the triangle to take a measured move and then project upwards from the resolution of the triangle. Why change traditional methods? Triangles develop five internal swings within the coiling continuation pattern. Elliott Wave analysts call the five internal swings waves a, b, c, d, and e. (See Figure 6.2.) If traders use conventional methods, they must wait for the triangle to conclude before creating a target for the thrust measurement. This is poor risk management if you think about it carefully, as a trader cannot define the true risk-to-reward ratio before establishing a position. So we will project a target that can be identified well before the triangle has developed fully.

  FIGURE 6.2 10-Year Japanese Government Bond—2-Month Chart

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

  We will not define a measured swing as the first step but will identify where support occurred prior to the start of the correction. In Figure 6.1, we will find support levels created by subdividing ranges into Fibonacci ratios of 38.2 percent, 50.0 percent, and 61.8 percent. Three ranges were selected that start at x and end at the price lows marked 1, 2, and 3 near the bottom left of the chart. As we drag our cursor down from x, we are looking for the strongest bars within the move, as we did in prior examples. We are trying to find support under the triangle, so we know the confluence zone we need must be under the first swing down from x. You will find other confluence zones in your data that fall within the triangle, but only one major confluence zone of support seems to form from within these three ranges that meets the criteria of confluence under the first leg down starting the triangle. The support zone is marked level m where a 50 percent retracement and a 61.8 percent retracement from two different ranges nearly overlap. Our real mission is not to find an old level of support far behind the correction. We are taking the time to walk through these steps so we can identify the midpoint of the rally that is developing. In this data, level m is defined as major confluence and support. This zone at ‘m’ is going to be used to create the next target. The lowest swing within a corrective triangle is often higher than the mid-, or center, point of the developing rally.

  Now we are ready to take a measured move of the rally before the triangle. The price low at A begins the sharpest leg up within this move. We discussed in prior chapters how a bar beginning a strong move is always an important internal milestone for any market regardless of the time interval we are viewing. (Using Elliott Wave terminology, we could say the start of a third wave or the third-of-a-third is important.) These ending points for ranges are always clearly defined, forceful price movement bars. In this case, the rally ends at point x. The range is marked by line AB. This is where this method deviates from tradition again. Now project a 61.8 percent ratio of range AB upwards from the confluence zone at m. The projected ratio relative to AB begins at point C, and the new price target is marked 61.8 percent. This is the first price high the market respected out of the triangle and follows the target with an eight-month pullback.

  How can I be confident that the confluence support zone identified at level m is the midpoint of the developing rally? A proportional measurement from a lower price low to the confluence zone can be made to see how the results compare. Using the boxes again, I measure from the confluence zone m down to the start of my data in this chart. The height of the box is the measured range marked AB. A measured move of equal length CD is then projected upwards from the confluence zone m. The market respected this equality target because the triangle begins from the same level as point D at the top of the second box. Now we know a mathematical grid line of great importance has been identified at m. The heavy black vertical line pq is the more conventional price projection the industry uses today, using a measured move from the triangle itself and projecting it from the end of the triangle. (Elliott Wave traders will reference the resolution of the triangle as wave e.) The method of convention is higher than the actual price high and gives no guidance for the first thrust out of the triangle that leads to the eight-month correction prior to the final rally. If your method varies to create a target out of a triangle, you may have used the length of wave b by extending the range back to the origin of the triangle (x in the prior chart). This target would have been off. If your method just took the range in wave b up within the triangle to define a target from point e, the measured move would be too high for the first swing out of the triangle and too low for the final top. By finding a support confluence zone behind the correction first, and then projecting a target, you will experience greater accuracy, and the targe
t will be identified much earlier. This is one of the most complex scenarios you will ever encounter as triangles develop when the market is rescaling its proportional grid. In this case, the market was contracting, and that is why confluence was significantly below the first leg down in the corrective triangle pattern. It is understandable as the market was in the final stages preceding a five-year correction that is still developing.

  In the shorter horizon, triangles will accurately move to a major confluence zone for the first price break or swing (in Elliott terms, wave A). It is then possible to develop an accurate target for the second swing, or wave B. But thereafter, the internals will break down through short-horizon price zones, and this character is of itself a clear warning you have entered a triangle and should not trade it. There is only one way to know a triangle will develop before it is on your computer screen: by finding a wide zone of astrological confluence targets along the vertical axis. Heavy congestion of astrological targets will cause this market action chop, or sideways coiling consolidation. The triangle usually ends right as the price data escapes the vertical congestion of time targets. This prior comment will likely make sense to Gann analysts only. But it is of such value to a trader, it is the primary reason I began to explore the methods of W.D. Gann. I wanted to know after a great run when I was going to hit my head against a brick wall of price chop and cause me to give a big portion of my earlier gains back. Knowing when the market is approaching a large confluence zone along the vertical time axis has proven to be an invaluable addition. We will look at vertical confluence in a moment.