by Brandon Wendell, Online Trading Academy
Although thought to have originated in India, Leonardo Bonacci (known as Fibonacci), has been credited with introducing the western world to the Fibonacci numbers used in many technical analyses. The most popular use of the numerical sequence is to measure price retracements for corrections and projections for new impulses in the trend. These levels will give you possible turning points for price and can be used as odds enhancers for supply and demand levels at which traders can enter trades and/or take profits.
The first thing you must do when using the Fibs, as they are known, is to identify the cycle or impulse in the stock or index you are trading. The cycle or impulse is the predominant direction and thrust of the security. We commonly call it the trend. In our classes we also teach how to identify the impulsive and corrective environments and what they mean to us as traders.
There are other Fibonacci techniques that can be used to anticipate changes in the trend. One such technique is the Fibonacci time projection. It is not as accurate as Fibonacci retracements or projections but can be used to warn of possible reversals or turning points in the current trend. There are three ratios that are most commonly used for the projections: 0.618, 1.0, and 1.618. The 261.8 projection can also be used. The projections should foretell of a change in the trend although it will not tell the exact direction of the change. Whatever direction price is moving at the time should reverse when you reach the time projection. This will be a stronger reversal when coupled with a supply or demand zone.
To use the time projection, you first identify an impulse in the trend direction. You extend the Fib from the start of the impulse to the end of it. Once that is done, your trading software will draw the extensions from the end of the impulse.
Let’s look at an example from a daily chart of the S & P 500. We had a major high on the 18th of August and then a swing low on the 24th. By counting the number of days between the highs and lows, including the high and low day, we arrive at our cycle to use for the projections.
As we see, on the date we reach the projection prices change direction. In essence, we have a reversal of whatever short term trend we are in. This may assist you in deciding whether to hold onto a position or to take profits.
Applying the Fibonacci time projections to the July 7th to 20th move in the S&P 500 index also proved interesting. The index turned at every projection and the 261.8 marked the August breakdown from the basing.
This can also work on intraday charts as well. Here we see projections on an intraday chart of SPY. By using the low and high of the morning, we were warned of possible changes in trends. The best signal was when price reached the 161.8 projection and a demand zone at the same time.
This technique is not perfect. We will not always see changes at all of the projected points but it works well enough to alert you as to when the market may shift. This can mean the difference between taking a nice profit on a trade and giving it back to the market.