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ST note - Fibonacci retracement
Summary: The Fibonacci retracement uses major swing high/low for anticipation of entry/exit levels with golden ratio 1.618 (or inversion of 0.618) being the key focus.
I think psychology of traders is one of the main drivers for price action whether you are trading stocks, bonds, commodities or currencies, but other factors like fundamentals are also crucial elements for equities as future prospects of company valuation should be mostly based on the earnings expectations while for majority of the asset classes out there, macroeconomic outlook influences business cycle – expansion/contraction - and interest rates that are determined by the central banks’ monetary policy.
Charts show only historic price action but still useful to look at the direction of trends over time and I usually try to keep them simple with daily candlesticks (or monthly) that show open/high/low/close even though there are probably hundreds of annotations and indicators. I sometimes use 200 day simple moving average which is useful to see the magnitude of the potential mean reversion or horizontal lines to identify resistance and support levels for any breakout or reversal trade opportunities. Other than these two, I used to also use the Fibonacci retracement using major swing high/low for anticipation of entry/exit levels.
Fibonacci numbers (according to Wikipedia) form a sequence, the Fibonacci sequence – that commonly starts from 0 & 1 - in which each number is the sum of the two preceding ones. E.g. 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144. As the numbers increase, the proportion between each pair of Fibonacci numbers becomes 1.618 (or inversion of 0.618) AKA the golden ratio (Greek letter Phi φ) and this ratio is not only used in art and architecture but also seen in some patterns of nature.
Ratio of Fibonacci retracements lines:
0.618 = 89/144
0.382 = 55/144
0.236 = 34/144
Example: Silver (XAGUSD)
Taking the levels – usually from major swing low to swing high or vice versa – doesn’t necessarily have to be precise all the time so round numbers could also be chosen. The first attempt to test $30 was in August 2020 then it retraced down to 22 which found some support then when XAG rallied again to make post COVID high 30.08 in February 2021 forming double top, it pulled back down to 22 where it established a solid support level. After a couple of months, the next swing high was formed near 27 that corresponded to 61.8% retracement. (refer to Chart A)
Once the key support level 22 was broken in May, the sell off continued until next support was formed at around 18 that coincides with previous resistance area during August 2019 & February 2020. Since then XAG was looking to bottom out but not without a number of retracements back down to 18. Applying the Fibonacci retracement from 2022 high 26.95 to 2022 low 17.55, first retracement was at 19.78 (23.6%) in Sep then 21.14 (38.2%) in Oct followed by 22.25 (50%) this month. If the reversal continues to the topside, then 23.36 (61.8) could be considered as a level to watch whether to set the profit target for longs or potential shorts. (refer to Chart B)