Fibonacci in trading
In previous lessons the basic concept of Fibonacci trading has been detailed. This discussion will focus on how to use Fibonacci retracements as part of your trading strategy. As seen by applying Fibonacci ratios on past trading opportunities, areas of previous share price support and resistance have been readily identified. Fibonacci ratios can also help predicting where future areas of possible share price support and resistance lie.
Firstly, the short-term trader/investor needs to have an opinion of what the share price has done in the recent past. The key question is, Has the share price broken out of a recent uptrend or down trend? Once this break has been identified, then the trader/investor can apply the Fibonacci ratios to see probable future areas of resistance and/or support. When used in conjunction with other indicative trading tools such as share patterns, oscillators, volume and the underlying move of the sector/index, Fibonacci ratios can provide a greater measure of probability. The one thing it cannot guarantee is certainty, so as always risk management tools need to be overlaid to ensure that the option or share trader/investor is not over-exposed to the one trade .
Using the above chart from March to July 2007 of Commonwealth Bank of Australia (CBA) as an example, the concept can be visually appreciated. If we start with the presumption that the underlying trend (red line) is up, then the short-term downward trend from early June to the yellow shaded area was within the underlying trend. By magnifying this 'bounce' and detailing the chart since the bounce you can see that the Fibanacci retracement levels yet again hold some credence, particularly when meeting the uptrend line.
For the shorter term trader, the Fibonacci ratio levels could act as key points to evaluate profit risk/reward returns while the long player could see them as key points to enter the market looking for a further bounce in the share price. It all depends upon your viewpoint.
National Australia Bank
Applying the Fibonacci retracement theory over the long-term view on the weekly chart for National Australia Bank Limited (NAB), shown below. When NAB was dropping from its highs (yellow shaded area) in June 2006, the first Fibonacci level shown (38.2%) and the upward trend line (red line) indicated possible support at or around the $33.40 to $33.60 level. It transpired that the low was above $33.00. NAB then continued its uptrend
This analysis may have given the invstor the confidence to buy on dips at around the $33 - $33.60 level.