The Hindu Business Line : Trader's Corner

The trader’s day would be made easy if there was an easy way of knowing where the stock will halt its slide and where the up move would reverse. The supports and resistances on the charts are the most widely followed methods for identifying these trend reversal points.

Another popular method that many technical analysts use to zero in on levels from where the stock price can reverse is with the aid of Fibonacci retracement levels. The famous Fibonacci series, 1, 1, 3, 5, 8, 13, 21, 34, 55 etc. derived from the problem relating to multiplying rabbits throws up these ratios.

If we divide one number in the series by the number to the right of it, we get the ratio 0.618. If we divide a number by another number two places away in the series, we get the ratio 0.382 and by dividing by the number that is three places away, we derive the ratio 0.236. The farther we move up the series, the closer the relationship gets to these ratios.

In order to derive the support and resistance levels based on these ratios, the vertical distance between the peak and the trough is multiplied by the ratios, .236, .382, and .618. For calculating supports, the levels derived from these ratios need to be deducted from the peak whereas for calculating resistances the levels need to be added to the trough.

The retracement level at which the stock halts its slide or checks a rally, gives valuable indication regarding the inherent strength in the move. A strong up-move would have shallow corrections that would mostly halt at 38.2 per cent retracement. A fall to the 61.8 per cent retracement level would mean that the bulls are tiring. A move below 61.8 per cent implies that the stock could plummet towards the previous trough again.

The Fibonacci ratios are useful in calculating the duration of a move as well. To derive the time projection, the time consumed by the previous move needs to be multiplied by the Fibonacci ratios and then added to the point at which the previous move terminated.

— Lokeshwarri S.K.

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