Trader’s Toolkit: Fibonacci Retracement Lines

Fibonacci retracement

In our first look at support and resistance, we examined several means of locating support and resistance levels, including:

  1. Former highs and lows
  2. Trend lines and channels
  3. Round numbers

Today, we examine several other possibilities, and reiterate that support and resistance can be mapped on a variety of time frames, from hourly to daily to weekly and everything in between.

Italian Mathematics

Let’s start our sojourn with a look at what’s termed a “Fibonacci retracement.” Named for the famous 13th century Italian mathematician, a Fibonacci retracement is a move that retraces by a specific percentage against the current trend.
We won’t get into all the math or what it’s based on here (though the topic is fascinating in its own right and should be studied by all). Suffice to say that naturally recurring pullbacks in a bull market – or higher surges in a bear market – tend to continue for exactly 61.8%, 38.2% and 50% of the prior move. Some technicians extend these numbers to include 161.8%, 138.2% and 150%, as well.
Charted, it looks as follows:
3M Fibonacci retracement
This is 3M Co. (NYSE: MMM) for a five-month span that saw a steep decline and subsequent bounce. As the chart shows, the decline was precisely 18 points and the bounce exactly 9, before strong resistance forced the stock lower. Smart traders might have considered exiting existing positions or entering new ones at the $88 level (in green).
Below, we see the opposite.
Target Fibonacci retracement
This is Target Corp. (NYSE: TGT) for six months of trade that saw a strong advance and subsequent pullback. Note the Fibonacci 38.2% support line that provides strong support at roughly $37.30. That number is calculated by taking the full measure of the former rise (20) and multiplying it by 0.382. The product that emerges (7.64) is subtracted from the former high (45) to get $37.36, where the green line is situated.
In this instance, too, traders waiting to launch bullish bets could have used the bounce above $37 as confirmation that support had held.
It’s also important to appreciate that the Fibonacci method does not offer to-the-penny accuracy.  In the case above, three days saw action at or slightly below the 0.382 level. Notwithstanding that, the technique is very often reliable and should be employed by all serious traders.

Failed Signals

Let’s look now at a Fibonacci signal that ultimately failed. In technical analysis, a failed signal is a potentially powerful indicator, as it suggests a strong move is about to unfold opposite to what we had expected.
This is a chart of Home Depot (NYSE: HD) for six months:
Target Fibonacci retracement
After a decline of roughly 25 points (in red), Home Depot begins to climb, passing Fibonacci 0.382 and 0.50 on its way to resistance at 0.618 (blue line). And there, a battle ensues between buyers and sellers for a full three weeks.
In the end, the 0.618 resistance line breaks, and the stock sails higher. How much higher we can’t be certain, as the chart is up-to-date as of this writing. Generally speaking, however, this is a situation where traders will look for upcoming resistance at 138.2%, 150% and 161.8% of the previous decline.
If that holds here, we would likely see Home Depot rise to at least $144-$145 before it ran into new sellers.

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in the Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.

To top