Fibonacci retracements, based on the naturally occurring Fibonacci sequence, together with the Elliott Wave Theory, have provided a means of predicting movements in the markets for almost 80 years, but many investors have been put off these methods by the fact that they can be tricky to apply. The new Automatic Fibonacci Retracements tool has made making predictions using this theory much simpler, and there is plenty of evidence to suggest that understanding how fluctuations tend to occur in proportion to previous movements in the market can be a useful factor in making trading decisions.
Why Fibonacci Retracements Work
Fibonacci retracements are based on the Fibonacci sequence of numbers, each of which is the sum of the two previous numbers. Fibonacci originally described this sequence in terms of the reproduction of a population of rabbits, so it is unsurprising that it can be found in many natural phenomena. It is a fact of nature that quantifiable traits such as population size or plant growth will occur in proportion to their magnitude in the past. This proportion is typically the same as is demonstrated by the Fibonacci sequence. Human nature is no different, and since movements in the markets depend upon human trading decisions, it is only to be expected that patterns reflecting the Fibonacci series seen in nature can also be observed in market fluctuations. Fibonacci retracements look for these types of ratios in the market and use them to predict future movements. The expectation is that both low and high peaks are likely to stop at points that are proportional to previous movements, particularly when they reach 38% or 62% of the original movement. The Elliott Wave theory extends this idea further, to predict movements that occur in a series of waves.
The turning points between waves can provide support areas where the market is expected to pause temporarily and then change direction. Knowing when such shifts are likely to occur can give investors a significant advantage, but, as with any predictive tool, it is important to be aware of the limitations of the technique as well as its possibilities. Fibonacci retracements and the Elliott Wave theory can enable patterns of movements to be analyzed in a manner that can complement the close market watching and news analysis that is advised by money.co.uk, particularly for potentially volatile markets such as Forex trading. Locating stable areas in these rapidly changing markets can make a significant difference to trading decisions. There will always be other considerations when choosing trades, whether it is an expected news release about the economy, or one’s own personal ethical choices about where to invest, but learning how to use these types of tools can be an important step towards managing your own investments rather than relying on an investment fund or manager. Many online brokers will offer the chance to test these methods using a virtual trading platform before you attempt it with a real investment, although the demonstration may be restricted to the most commonly traded currencies, which money.co.uk names as the EUR, USD, GBP and YEN. This can be a good opportunity to see how well Fibonacci retracements reflect the real world.
Waves in the S&P
A recent example demonstrating how Fibonacci retracements can work comes from the S&P 500 in July 2013. A series of fluctuations in this market followed the predictions of the Elliott Wave Theory and Fibonacci retracement very closely. The predicted fluctuation, as described by technical analyst Walter Zimmerman in the Wall Street Journal, were originally based upon the rise from a low point of 1560.33 to a peak at 1626.61 on July 1st, and the dip that followed, down to 1604.57 on July 3rd. According to the theory, markets will tend to follow a pattern of five waves, with a rise and fall, another rise and fall, and a final rise that will reach the highest point in the series. Based on the first two waves, Fibonacci ratios made it possible to predict the course of the next three waves. It was expected that there would first be another rise, a third wave peaking at about 1711.81. Next, the S&P 500 would fall again, in a fourth wave descending to 1686.50. Finally, a fifth wave would occur, bringing the S&P 500 up to its highest peak in the pattern, estimated to be at 1752.78.
Looking at what really happened to the S&P 500, we can see that this prediction turned out to be fairly accurate, although there was some deviation from the “technical perfection” described by Zimmerman. The S&P 500 did indeed rise again, to a peak of 1709.67, fell to a low of 1630.48, and then rose again to peak at 1725.52. The predicted pattern is clearly present, although the exact predictions were slightly different. The main issue with the prediction was that the fourth wave fell further than expected, past 1660, the point at which Zimmerman suggested he would need to recalculate his predictions.
Making Predictions using Fibonacci Retracements
Applying similar methods to the Forex market, using the Automated Fibonacci Retracement tool, makes it possible to gain a better idea of how current waves are likely to be followed by proportional fluctuations in the near future. An Elliott Wave analysis of the market in September 2013, for example, would suggest that the USD is likely to experience a short-term drop against EUR, GBP and CHF, as the fourth wave reaches its lowest point, before the final fifth wave recovery begins.
