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  • by Clint Cowles, CMT

Forecasting Price Targets with Fibonacci Drawings

Most people involved in the financial markets have probably heard of Fibonacci retracements, or at least the general term Fibonaccis.  But Fibonaccis can be a lot like modern art, Bitcoin, or CrossFit; it sounds cool but they don’t necessarily understand it.  I mean try saying it out loud – fih-boh-nah-chee – see? Fun.

Others may have even drawn a few on their charts to help identify upcoming support but still don’t quite know how to read it.  We’ll take a look at how it’s done and why it works, but we’ll also take it a step further and use multiple drawings on the same chart to increase the probabilities of finding the right levels.

Where did the term come from?

The concept is all derived from the Golden Ratio, which is reached by dividing one term in the Fibonacci sequence by the one before it = 1.618 : 1.  If you take the inverse 1/1.618 you’ll reach our most common Fib retracement level, 61.8%.  This aligns with human behavior as well.  There have been studies dating back to ancient Greece where you draw a line for a person and ask them to divide it unequally.  Most people will divide that line very close to 61.8% of the way across. Try it on your favorite brother-in-law and show him how “normal” he is.

It’s doodle time

Alright, back to the charts.  We’ll start with the basics, Fibonacci retracements.  These are fairly simple to add to a chart with two clicks.  Once you choose your drawing tool, click once at the bottom of a swing move, then a second time at the top.  (It would work the same in a bearish trend.)  The next step would be to choose a slightly longer time frame and do it again, and again, and again.  Below you will find a chart of SPX from the January 2016 low through today.  The only real top that occurred in that timeframe was at the end of January 2018, so that will be my ending point.  Now work back and find all of the intermediate term lows that occurred during that timeframe and draw a retracement from that low to the end point at 2872.87.  What you’ll see is a chart that looks like a toddler drawing a freight train, but there’s hope!  What we’re looking for are “confluence zones”.  These are prices where multiple retracement levels align very close to the same price.  If we draw price levels over the confluence zones, then delete the original retracements, the picture becomes much clearer.

For illustrative purposes only.

Here we can take that train wreck of a drawing set and boil it down to four important price levels shown below.  We’ve also drawn one upsloping trendline connecting the two most recent lows in SPX.  When the market drop started, we could see initial support at 2600, then 2530 after that.  Adding in the upsloping trendline added a bit more confidence to the 2530 level that ultimately held and started the rebound we’ve been experiencing since.

For illustrative purposes only.

Now that we have our support levels identified, let’s look for a potential resistance point if we break the January high.  This can be a bit tricky when looking for a price level the index has never traded at before so we’re going to use a combination of retracements and extensions to forecast those levels.  We’ve discussed the retracements, but here we’ll use them differently.  We want to measure the major swing move from the January top to the February low which will be the start and end of our drawing.  That will place the same three lines we used before, just in the other direction.  I’ve added one more retracement at 161.8% (1.618 is the Golden Ratio) to project resistance of 3,090, if the previous high is breached.  Now to the extensions.  For this study, we’ll measure the first bullish move off of the low and project that forward off of the next low from early March. The 61.8% extension brought us to 2800, which has already acted as resistance once, the 100% level is very close to the January high, and the 161.8% extension is at 3,090, also lining up with the 161.8% retracement level we just identified.

For illustrative purposes only.

Fibonaccis can give you some potential support and resistance levels to work with just by measuring a past move in price, but combining multiple Fibonacci drawings on the same chart can provide a clearer picture of which levels may be stronger.  When you reach the same conclusion through different calculations, you have a better chance of getting it right.  Fibonaccis can help bring some clarity to the market at times when things don’t seem to make sense.  They are also able to project potential resistance levels at prices never seen before, making them a rare tool for navigating uncharted territory.

While this article  discusses technical analysis, other approaches, including fundamental analysis, may assert very different views.

This material is designed for an investment professional audience, primarily Registered Investment Advisors (RIAs).

Past performance is not a guarantee of future results.

TD Ameritrade Institutional, Division of TD Ameritrade, Inc., member FINRA/ SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.



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