Fibonacci fan and arc

The way in which Fibonacci numbers can be used for analysing stocks goes much beyond retracements and time-lines. There are some lesser known and less widely used tools such as the Fibonacci fans and arcs that can also be used effectively by traders and analysts.

The Fibonacci fan is a three-line tool that uses the ratios .382, .50 and .618. The genesis of these ratios was discussed in the previous Traders Corner columns. To draw the Fibonacci fan, a trend line is drawn from the nearest peak to trough or vice versa. The vertical distance between a peak and trough multiplied by the ratios .382, .50 and .618 and deducted from the peak or added to the trough where the trend-line ends.

Then three lines are drawn from the leftmost point in the trend line to intercept the vertical line at the three levels derived by the ratios. What we get is a Fibonacci fan with three lines.

Following a down-trend, these fans move down from the peak thus providing resistance levels for the following up-move. After an uptrend, the fans would fan upward providing support levels for the next down-move.

If we take the long-term chart of Reliance Capital and draw the fan from the January 2008 peak of Rs 2,925, the result is astonishing. The first fan-line at Rs 1,000 halted the stock's rally in June 2009. The stock has been unable to surpass this level to date!

A more picturesque way of utilising the ratios to derive supports and resistances is by drawing the Fibonacci arcs. The initial steps for drawing the arc are similar to that for drawing the Fibonacci fan. The ratios are multiplied with the vertical distance between a peak and a trough. Then arcs are drawn through these levels.

Let us take a look at the long-term chart of HDIL to see the effectiveness of the Fibonacci arcs. When these arcs are drawn based on the trend-line down from the January 2008 peak to the March 2009 trough, we can see that the up-move in the first quarter of 2009 halted at the point where the first arc met the price, at Rs 410 in October 2009. This level turned out to be a significant long-term peak for the stock.

The 38.2 per cent retracement line for this down-move was much higher at Rs 465 and could not have helped the analyst. The fan lines were also not of any use in this case.

As the security moves up after a down-move, the Fibonacci fan lines and arcs provide the levels where the price would encounter resistance. Similarly, in a correction, these fan lines and arcs provide the support levels.

As the examples provided above show, these tools give stunning results at times. An analyst or trader can improve his skills with these tools over time. To begin with, the Fibonacci fans and arcs can be used in conjunction with other tools. The convergence of many tools at a specific support or resistance would make that level an important reversal point.

The major drawback with these tools is that they tend to lose their relevance in a prolonged sideways move. Secondly, since they are less used, they do not enjoy the psychological advantage that the Fibonacci retracement does.

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