## Why Fibonacci?

Fibonacci Analysis is one of the most valuable and easy to use tools that we have as market participants. I’ve studied supply and demand behavior for over 15 years and I find myself using Fibonacci tools every single day. These tools can be applied to all timeframes, not just short-term but longer-term. In fact, contrary to popular belief, technical analysis is more useful and much more reliable the longer your time horizon. Fibonacci is no different. Here is the S&P500 going back to the peak in 2007. After breaking out in 2013, the market stopped at exactly the 161.8% extension of that entire 2007-2009 decline. That wasn’t a coincidence. I’ll do my best to explain why throughout this module.

## Many of Them Hate Fibonacci

First of all, let’s discuss the “stigma” that surrounds Fibonacci analysis. The academic community hates it and I think the fundamental guys hate it even more. The funny part is when markets are crashing, they’re the first ones calling us technicians asking which are the next levels to watch. We hold our heads up high and just tell them, and let them keep convincing themselves they don’t need to analyze price behavior. It’s their loss, not ours.

Media-wise, they definitely hate it. On two separate occasions, on two different TV networks, I’ve been told my the producer a couple of minutes before going on live that, *“We don’t use words like Fibonacci around here, so please do not mention that”*. I kid you not. But most of the financial media is completely lost anyway, and they’re objectives are not to make money in the market, it’s to sell ads, so it should not be surprising.

Here I am on Bloomberg TV explaining to the lovely Trish Regan that our downside targets in Blackberry are based on off of key Fibonacci Extensions:

## History of Fibonacci

If you are not concerned with the math behind the tool, **skip down to Execution**

We first see Fibonacci in Indian mathematics and is attributed in part due to work done in 200 BC by mathematician and author Pingala. We don’t know much about the author, but outside of India, the Fibonacci sequence first appeared in *Liber Abacci* in the year 1202, a book on arithmetic written by Leonardo of Pisa. We know him today as Leonardo Fibonacci. In this book, where he introduces the Fibonacci sequence to Europe, he posed the following problem:

### The Problem

Fibonacci imagines a biologically unrealistic scenario for the growth of a population.

How many pairsof rabbits placed in an enclosed area can be produced in a single year from one pair of rabbits if each pair gives birth to a new pair each month starting with the second month?

### The Solution

The amount of Rabbits increasing as months pass by is the Fibonacci sequence. What we know is that each pair including the first pair needs 1 month to mature. Once the pair of rabbits are in production, they birth a new pair each month. Since they need a month to mature before, the number of pairs is the same at the beginning of the first and second months. That’s why the Fibonacci Sequence starts with 1,1.

In the second month, the first pair doubles so the sequence expands to 1,1,2.

*From Robert Prechter*

Moving on, the oldest pair now gives birth to a 3rd pair so to begin the 4th month, there are now 3 pairs. The Sequence is now 1,1,2,3

Now with 3 pairs of rabbits, the oldest 2 are in production but not the youngest pair. So the older 2 reproduce making it a total of 5 pairs of rabbits. This takes the sequence rto 1,1,2,3,5. The following month, 3 pairs give birth, but not the younger 2, so it makes it 8 in total

After 12 months, there will be 144 pairs of rabbits.

### The Golden Ratio

But it’s not the answer to the problem that is brilliant. What we want to focus on is the way in which we arrived at the solution. You see, if you add up any two adjacent numbers in the sequence you’ll arrive at the next number in the sequence. 1 plus 1 equals 2. 1 plus 2 equals 3. 2 plus 3 equals 5. 3 plus 5 equals 8 and it goes on and on….

This Fibonacci Sequence is how we calculate the Golden Ratio. After the first few numbers in the sequence, the ratio of any number to the next higher number in the sequence (adjacent to right) is approximately 0.618 to 1. Also, the ratio of any number to the next lower number (adjacent to left) is approximately 1.618 to 1. The further along you go into the sequence, the closer those ratios approach 0.618 and 1.618.

Feel free to follow along on your calculator. 34 divided by 55 gives you point 0.618. If you move along the sequence and divide 610 by 987, once again you get point 618. Now, flip the math and divide each by the previous number in the sequence. For example, 89 divided by 55 gives you 1.618. 377 divided by 233 gives also gives you 1.618.

## Execution

There are two simple ways that these Fibonacci numbers can be used. Retracements, which are for counter-trend purposes, and Extensions which are for stronger trends. Both can be very helpful in downtrend as well as uptrends.

### Retracements

For retracements, we’re looking for the end or at least a temporary pause after a counter-trend market move. In other words, we’re trying to find a target for a sell-off within a larger uptrend, or an end to a rally within a larger downtrend. Here is an example of the 61.8% retracement coming into play within an ongoing downtrend. This level represents approximately 61.8% of the entire decline, peak to trough:

These Fibonacci levels can be used to calculate targets regardless of the asset class. We can be looking at U.S. stocks or sector ETFs, Indexes like the S&P500, Futures Markets, Currencies, etc etc. Also, remember that the market is fractal. These levels often come into play on longer-term weekly timeframes, intermediate-term daily timeframes, and often intraday. So it doesn’t matter how long your time horizon might be or what sort of vehicles you have in your portfolio, these principles can be applied across the board.

Also, when I draw these lines, I don’t calculate the exact low to the penny or exact high to the penny. Some software providers do that for you automatically but others don’t. It doesn’t matter either way. We just want to get very close. With Fibonacci, or with support and resistance and even trendlines, we want to draw these levels with crayons, not sharpened pencils. So you’ll never see my Fibonacci extensions match up to the penny. I don’t waste my time with irrelevant calculations. Besides, the market doesn’t react to the penny either, it respects the areas. That’s the point of this.

Here is a chart of JP Morgan $JPM back in 2009-2011. The stock put in its epic bottom in March of 2009 along with many others at the time, and then went on to rally into the Spring of 2010. The initial correction into the Summer found support right near the 38.2% retracement of that prior move. The market then went on to rally back to those former highs. After running into prior resistance, $JPM fell apart once again sending shares much lower, this time taking out those former lows near the 38.2% retracement. The next logical area of support was the 61.8% retracement of that move off the March 2009 lows. That’s where the market found support and prices of $JPM went on to rally to new highs from there:

### Extensions

I can give you thousands of examples like these, but I think you get the idea. Next, I want to talk about extensions. These Extensions help when we are looking for targets within an ongoing market move. In other words, we’re trying to find an upside target within an ongoing uptrend after taking out a previous high or trying to find a downside target within an ongoing downtrend after taking out a previous low. Here is an example of the 161.8% extension coming play within an ongoing uptrend after first correcting. The level in red represents approximately 161.8%

Here is a chart of the Oil & Gas Exploration and Production ETF $XOP from 2009 through 2014. Yo can see the peak in early 2011 followed by a swift decline in to the late 2011 lows. After finding support near those 2010 lows around $37, prices rallied all the way back to the prior highs. In 2013, prices exceeded those former highs and “broke out”, if you will. You can see starting in early 2014, prices started their next leg higher. The target becomes the 161.8% extension of that entire 2011 decline. Notice how prices stalled right and immediately started falling:

**$XOP**

Here is Tesla in 2017 getting up to the 161.8% extension of the 2014-2016 decline. This doesn’t just happen by coincidence.

**$TSLA**

The same can be seen to the downside during downtrends. Here we are looking at the Euro vs the U.S. Dollar $EURUSD in 2012. This market put in its low in early 2012 and went on to rally for a couple of months. All of this was within an ongoing downtrend. Once prices in May took out those former lows near 1.26, the next logical target was the 161.8% extension of the prior rally. This gave us a target just under 1.21 which is precisely where $EURUSD found its bottom that Summer and then went on to rally and make new highs:

**$EURUSD**

I can go on and on giving you example after example, but I’m just going to leave it here. If you’re not already a member, I highly recommend starting a 30-Day Risk Free Trial with Allstarcharts.com so you can see this Fibonacci analysis across asset classes and timeframes in real time. The Chartbook has over 500 charts, constantly updated with all of the Fibonacci extensions and retracements whenever appropriate to current trends.

**Note: After the 161.8% extensions, we can calculate the next targets using the same math. I will be uploading this lesson with examples this week. They include the 261.8% extension, 423.6% and 685.4%.**

One thing I would like to reiterate is that only price pays. Supply and demand is based on support and resistance defined by prior levels where shares changed hands. Fibonacci, just like every tool outside of price, is only supplemental. Fibonacci works best when either multiple Fibonacci levels cluster together, or when Fibonacci levels coincide with former support or resistance. But again, all of this is just a supplement to price, just like volume, or momentum, or the use of smoothing mechanisms, or sentiment or seasonal studies. Only price pays, but Fibonacci certainly helps.

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