Username
Password
Forget Password?
  1. Indices
  2. Commodities
  3. Currencies
Straits Times 3,114.16 -11.98 -0.38%
Hang Seng 26,719.58 -128.91 -0.48%
Dow Jones 26,770.20 -255.68 -0.95%
Shanghai Composite 2,938.14 -39.19 -1.32%
Fibonacci Retracement – Waiting For The Right Moment (Part I)
Education | 25 May 2012
By:

By ChartNexus

The Straits Times Index (STI) encountered a major sell-down in early May 2012 which pushed stocks to their multi-month lows. In the financial markets, many people are looking for big rewards and are thinking that they could make a killing by buying stocks at their perceived low price. However, largely unknown to beginners, the lack of a comprehensive trading strategy or technical knowledge in analysing the behaviour of the stock market is leaving them exposed to a high level of risk. On the other hand, most experienced traders understand the behaviour of the stock market well and would know how to anticipate price movements in any given time frame. For example, some stocks would form chart bottom formations before resuming their uptrends while some stocks with stronger bullish sentiments would resume their uptrends ferociously. Either way, experienced traders would know how to identify when is the best time to take up positions where the level of risk is lower. Therefore, it is crucial for beginners to learn some form of technical analysis so as to time their trades better. No one likes to buy high and sell low, but not many know how to buy low and sell high. This first half of a two-part article will introduce an effective tool that will help identify the chart bottoms and the best time to enter the stock market. The name of this well-known tool is the Fibonacci Retracement. We will also be discussing how Fibonacci Retracement can be used to manage and minimise risk in the stock market.

The Fibonacci sequence is a series of numbers that were first derived by Leonardo of Pisa in the 15th century after observing the population expansion of a pair of rabbits. Recognising the importance of Fibonacci numbers to real-life application, mathematicians derived the Fibonacci Retracement levels for trading in the stock market; the latter levels being made up of 6 percentage numbers or lines. For an uptrending stock, the Fibonacci Retracement lines are drawn depending on the preferred trading period of the trader, by first identifying the bottom and then the top. After the identification of the bottom and then the top, we will calculate the retracement levels between the highest price and the lowest price. Nowadays, this can be done by a simple click of the mouse. Most charting software products in the market allow you to draw the Fibonacci Retracement levels effortlessly. ChartNexus is one such tool which also comes with free download of end-of-day data. The Fibonacci Retracement levels commonly used are 23.6 percent, 38.2 percent, 50 percent and 61.8 percent with the most significant levels being 38.2 percent, 50 percent and 61.8 percent. As the saying goes, what goes up must come down. In an uptrend, a stock will achieve higher highs and higher lows. Fibonacci Retracement is used to identify the price level as it retraces to a higher low before testing the higher high. The first possible level of support for a retracement is usually the 38.2 percent line.

COSCO Corporation

Figure 1 illustrates how the 38.2 percent line is being used to test the effectiveness of the support as shownin the chart of COSCO.

Figure 1: COSCO rebounding off the 38.2% level

Notice after forming a top on February 2012, COSCO began to pull back. On 7 March 2012, the stock tested the 38.2 percent level and subsequently rebounded off the level. Thereafter this 38.2 percent level represents a minor support for COSCO as it was tested one time on the technical chart.

Goodpack

Figure 2 shows Goodpack rebounding after hitting the 61.8 percent line.

Figure 2: Goodpack rebounding off 61.8% level

However, the 61.8 percent line is also known as the last line of defence for the stock price. A break below the 61.8 percent line usually means that the uptrend of the stock is negated.

Oversea-Chinese Banking Corporation

In Figure 3, OCBC broke the 61.8 percent line on 8 February 2011 (in red) and the stock price went down further thereafter.

Figure 3: Using Fibonacci Retracement lines as support and resistance levels

As observed from Figures 1 and 2, Fibonacci Retracement levels offer very strong support or resistance to the price movements. In Figure 3, we see that OCBC’s stock prices were able to find good resistance at the 61.8 percent line during April 2011 after the Fibonacci 61.8 percent level was broken on 8 February 2011. OCBC went into a downtrend shortly thereafter.

In our next part which will be featured in issue 436, we will explain how the usage of the Fibonacci Retracement levels can be enhanced with a combination of other indicators.

ChartNexus is a regional company providing FREE charting software for the investment community.  The company also organises investment seminars and training program on a regular basis, promoting the use of technical analysis.  For more information, please visit www.chartnexus.com or email gevents@chartnexus.com.


Join The Conversation
The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

All Rights Reserved. Pioneers & Leaders (Publishers) Pte Ltd. Best viewed with Mozilla Firefox 3.5 and above.