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Two Is Better Than One, Combining With Other Indicators – Fibonacci Retracement Part 2
Education | 26 July 2013
By: Shane Goh
Articles (99) Profile

In part one of our series, we introduced the Fibonacci Retracement, a technical analysis tool, which is able to calculate potential support and resistance levels based on a previous movement in the stock price.

To recap, we will need to plot a vertical line from the top to the bottom of a movement and intersect it with horizontal lines at percentages (eg. 38.2%, 50% and 61.8%) based on the Fibonacci number sequence.

As mentioned previously, technical indicators are rarely employed individually but combined with other indicators to enhance the depth of our analysis. In this article, we will explore three such indicators: 1) Relative strength index (RSI) 2) Moving averages (MA) 3) Trend lines.

Figure 1: Day Chart For Q&M Dental Group

Source: FactSet

RSI, which produces overbought or oversold signals, can be used in conjunction with Fibonacci retracement to find a potential point of entry or exit. If the RSI level is above 70, the stock is considered overbought while if it is below 30, the stock is considered oversold. Following the downtrend in Figure 1, a day chart of Q&M Dental Group, we have plotted the Fibonacci retracements on the chart from point A to point B. As the stock price gapped up and attempted to pierce through the resistance of 68.2% at point C, we noticed that RSI’s level was above 70 at point E, signifying an overbought market condition. We experienced a correction in the price to the 23.6% level before it spiked up once more to the 68.2% level at point D. Once more, we witnessed the RSI level close to 70 at point F. In both instances, a combination of the RSI’s level above 70 and a Fibonacci retracement level at 68.2% provided a strong resistance which held firm against the upward movements.

Figure 2: Day Chart For Genting Singapore

Source: FactSet

MAs, a measurement of the mean for a stipulated number of days, are usually plotted with both a faster and slower moving average on the chart (eg. 14 and 50 days). A faster MA crossing the slower MA from above produces a sell signal while the faster MA crossing the slower MA from below the displays a buy signal. Following the downtrend in Figure 2, a day chart of Genting Singapore, we have plotted the Fibonacci retracements on the chart from point A to point B. Initially, the price shot up to point C before tumbling back down. At point D, we observe the price testing the support of 38.2% and the faster MA cutting the slower MA from above signaling a sell. If the price holds firmly above the support, we would expect the crossing of the MAs to reverse and an upward trend to follow. As the share price broke the support, helped by the crossing of the faster MA from above the slower MA, we witnessed a downward movement in the stock.

Figure 3: Day Chart For AusGroup

Source: FactSet

Basic trend lines could form a part of your analysis when used together with retracement levels. In Figure 3, a day chart of AusGroup, we noticed an upward movement and drew a trend line connecting the lows of the stock price from point C to point D. Upon introducing the Fibonacci retracement from point A to point B, we notice an intersection between the trendline and the retracement level of 50% at point E, signifying strong support at that price, where traders will look to buy the stock. Conversely, if the price breaks the support, it could signal potential trend reversal and traders might want to err on the side of caution. In this scenario, the stock price broke the trendline and the 50% level without a quick reversal above the level or trendline, resulting in a downward movement.

As a rule of thumb, having three or more indicators providing a similar outlook offers a higher chance of success. However, as with any trade taken, always have a plan B in the event your original analysis does not pane out. In the case of Fibonacci retracements, you may consider using the previous level as your cut loss point when aiming to break the upcoming barrier.

In the next part of our series, we will explore the Fibonacci Extension.

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

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