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Using Fibonacci to identify potential turning points
In my last blog post, I talked about some “topping” chart patterns used in technical analysis. Since Elliott Wave International is giving away a free e-book on using Fibonacci to identify turning points this week, I thought I would continue my series on technical analysis and write a post on how I use Fibonacci Retracements in my market analysis. I realise that this term might be greek to many Australian stock investors. Well, it is italian actually, as Fibonacci was an Italian mathematician who first observed some common ratios, namely 0.382, 0.5 and 0.618 which tend to occur frequently in nature. In stock market analysis, these ratios can be used to identify potential turning points in the market. Below is a weekly chart of the S&P 500 index where I have drawn the Fibonacci Retracement lines for the market move from the highs of Oct 2007 to the lows of March 2008. A rally started in March 2008 but you will notice that market turned when it reached the 50% retracement level at around 1420.
When I first heard about Fibonacci levels, I was quite skeptical about them but when we were learning to trade futures, we saw prices turn at these levels so often that it was hard not to be convinced that they work, even if you don’t understand why they do. Short-term traders use Fibonacci levels extensively but they are just as useful for longer term investors by applying them on longer term charts like weekly charts. If you think that maybe it works in the US markets because there are many technical traders using them, who may be actually causing the markets to turn at those levels, here is a weekly chart of the Shanghai composite index. I don’t think there are many Chinese share traders who know about Fibonacci but their market did turn at the 38.2% retracement level in August 2009.
So how about the Australian market? When I plotted the Fibonacci retracement levels for the All Ordinaries Index for the market move from Oct 2007 to March 2009, I was not surprised that the October 2009 highs of 4900 coincided with the 50% retracement level, and the market turned after touching this level. Although it is too early to say if this turn will lead to a new leg down, it is not a bad point to place a hedge. The market could push through the 50% retracement level and make another leg up to 5500, which is the 61.8% retracement level.
The chart below is similar fibonacci retracement chart for the S&P 500 for the Oct 2007 to March 2009 move. As you can see, the SPX is also at the 50% retracement level. This point also concides with the down trendline (marked in green), which adds further resistance to the upside. Technical analysts everywhere are watching the 1120 level very closely, to see if the market will turn at the point, or give us a Christmas rally to the 61.8% level at 1225.
If you want to learn more about Fibonacci levels and how to use them to identify turns in the market, download the free e-book “How you can identify turning points using Fibonacci” before 7 December 2009.
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[...] retracement levels are potential turning points in markets as mentioned in my earlier blog post “Using Fibonacci to identify potential turning points“. Marketclub had just released a great video analysis on the DOW called “Can we go [...]