Stepping Up Your Fib - Part 3

The use of Fibonacci in terms of market relationships gained popularity over the past decade, moving from widespread use in the futures market to all forms of securities. In the first two installments of this series on Fibonacci I covered the history of Fibonacci series, the underlying basis for its popularity, as well as how to draw and read Fibonacci levels in the market. In this third and final segment of the series I will be moving from abstract concepts to practical uses for Fibonacci in everyday market environments.

Utilizing Multiple Fibonacci Levels

One concern with traders when it comes to applying Fibonacci levels to a security is which trend moves to focus upon. How does a trader determine which move is significant and which to ignore?

In reality, every trend move is important in determining another upcoming move in price, but there are a couple of things to keep in mind. First of all, the larger the time frame under examination, the more significant the support and resistance levels are on that time frame. This applies to not only Fibonacci price support and resistance levels, but any other form of price support or resistance as well. Another thing to realize while dealing with these larger time frames is that each support or resistance zone will be wider than on a smaller time frame. This means that they will tend to be more elastic and not hold exact price levels perfectly.

In Figures 1 and 2 below I have drawn two separate sets of Fibonacci levels. The first set in Figure 1 shows the Fibonacci levels as they play out following the last major downside move on the 5 minute chart of the S&P 500 EMini contract (ES) on 3/19 from approximately 5:10 pm ET into 9:40 am ET on 3/20. The Fibonacci levels are drawn by connecting the highs of the move to the lows the following morning. A, B, and C are examples of the Fibonacci levels serving as resistance, while 1, 2, and 3 show mid-level support zones.

Figure 1- 5 Minute S&P 500 EMini (ES)

In Figure 2 the reversal off the previous downtrend move is the primary focus and another set of Fibonacci levels was drawn, connecting the lows of the price move on the morning of 3/20 to the highs around 11:30 am ET. While A and B are both quite different than they were in the first figure, 1, 2, and 3 are all in the mid-level area once again. Each mid-day pivot low corresponded to a Fibonacci support level based upon not only the move from the prior afternoon into lows, but also the retracement levels which were based upon the move higher the following morning.

Figure 2- 5 Minute S&P 500 EMini (ES)

Although each of these previous charts seems rather straight-forward, often the main trend upon which a set of Fibonacci levels was established will move off to the left of the chart as prices develop and no longer are displayed as new trend moves form.

What these charts show, however, is that even after a new move has formed, such as in Figure 2, the Fibonacci levels from Figure 1 still remain valid. In order to view all of these levels clearly as price action plays out, I typically will display several sets of Fibonacci levels on the same chart, as I have in Figure 3. By giving the different bands different colors, I can quickly discern how the price levels relate to the original trends upon which they were based.

When more than one level is hitting at approximately the same time, such as over noon on 3/20, those levels are often quite strong.

Another way to weigh the strength of a certain Fibonacci level is to look at other indicators or forms of support and resistance. Those which correlate very highly to a certain Fibonacci level will tend to be more significant.

In each of the charts in this article I have included a 20 period and 200 period simple moving average. The 200 sma acts as resistance on the morning of 3/20, hitting at the same approximate time as the 61.8% Fibonacci retracement level from the prior afternoon?s descent. It is resistance once again in the early afternoon, shown as "B" in Figure 3. It doesn?t reverse prices in the ES, but in the Nasdaq 100 EMini (NQ) (not shown here) the prices pulled back at that same resistance point to form a bull flag while the S&Ps congested.

In "5" on Figure 3 the 20 period sma hits at the same time as the -38.2% level from the morning rally, allowing it to easily bounce back into the highs in the final minutes of trade.

Figure 3- 5 Minute S&P 500 EMini (ES)

When using Fibonacci levels, I will often keep a set of levels up for several days. Figure 4 shows a move which took place on the morning of 3/19, before the prices in the earlier examples even had a time to play out. What is important to notice, however, is how much overlap there was in terms of where the Fibonacci levels from the first drop on the 19th played out and how well they corresponded to Fibonacci levels that would be based upon later trend moves.

For instance, "B" in Figure 4 is the same area where the move in Figure 1 began. It was the -38.2% level from that morning's drop.

"D" in Figure 4, is nearly identical to "B" in Figure 3, while "E" is in the same zone on both charts.

"3" in Figure 4 is also within just a couple of ticks from the "5" level in Figure 3.

When I have so many levels up that it becomes overwhelming, I will clear my charts and update them with the most recent relevant trend moves.

Figure 4- 5 Minute S&P 500 EMini (ES)

Fibonacci Levels, Gaps, and News Environments

While Fibonacci levels work very well in typical markets, they also hold well when circumstances are less-than-normal and greater volatility, or news is at hand.

Figure 5 shows a set of Fibonacci levels that are based upon a gap instead of the typical intraday trend from the prior examples. By connecting the lows of the closing move to the highs of the gap move, the -38.2% level from that gap predicted the morning highs.

Figure 5- 5 Minute S&P 500 EMini (ES)

3/18 was also a Fed day. Despite the rapid whip-saw action following the interest rate cut announcement, Fibonacci levels still held well. The 0% level was some initial support, but the continuation into the 38.2% level was more significant, holding perfectly for the rally into the close. Applying Fibonacci levels to gaps is a great way to help figure out what the support or resistance levels are that fall in between the closing and opening prices of the security, even when news is fueling the retracement.

These levels also continue to remain valid for days following the initial gap. This is shown in Figure 6. Since each of the subsequent levels also lines up with prior highs or lows it adds even more strength to them as support and resistance levels.

Figure 6- 5 Minute S&P 500 EMini (ES)

Other ways to Use Fibonacci

Many strategies exist which take Fibonacci series even further than the key concepts I have discussed in this series. In addition to support and resistance, for instance, Fibonacci can also be applied to time.

Instead of connecting highs to lows to map out horizontal levels, some traders will connect them to map out vertical levels to show time development and give them a heads up as to when a new trend move is likely to turn.

Other uses for Fibonacci tie into using them as moving averages, or even basing time frames and chart setups upon them. I tend to think that chart configurations are more in the eye of the beholder and it does not matter whether my tick chart on an ES is set up based upon a Fibonacci number or a set number of ticks such as 200, but I'll leave that up to you!

To learn more about the unique style of technical analysis I use for locating high probability trades, check out my Trading Made Simple CD series at www.swingtrader.net Please feel free to email me with any questions or comments you may have by clicking on the contact link located on my website at www.tradingfrommainstreet.com.

Toni Hansen is one of the most respected technical analysts and traders in the industry with a high reputation for accuracy in both bull and bear markets. Her style of trading and market analysis transcends both time as well as market vehicles, making it attractive to investors and trader of stocks, futures, options, ETFs, and even the FOREX market. Toni is a frequent lecturer at trading clubs and industry expos. She is also a popular market columnist and is a repeat contributor to SFO Magazine. She recently co-authored High Profits in High Heels from Marketplace Books and SFO's Personal Investor Series book Online Trading.