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Using Fiboancci Ratios to
Forecast Price and Time

FIBONACCI RETRACEMENTS

Almost everybody is familiar with measuring Fibonacci retracements. A ticker advances 100 points and then declines by 62 points before taking off again in another rally leg. In this case the retracement is 62%. Along with 38% and 50% (which is not a Fibonacci number) these are the most common retracement levels. For many people this all they know about Fibonacci Retracements, and perhaps Fibonacci Numbers in general, and even for them this is a good piece of information to have. If your work tells you that this pullback is most likely a temporary decline before the beginning of the next upleg, when it appears likely that the top is in at 100 you can mark your charts and watch for a reaction at the different Fibonacci levels. We call this a Reaction or Decay Retracement. During this Retracement phase Price is moving against the major trend, and if you are correct about the direction of the major trend, price should decay somewhere between 14.6% and 78.6% before resuming its move in the direction of the major trend. Easy enough.

But Fibonacci Retracements are not limited to the garden variety Decay type. Fibonacci Numbers appear so frequently in nature because they demonstrate the pattern of change and growth. And so too can this pattern of change and growth be applied to the financial markets. In the first example we limited ourselves to describing the likely extent of the pullback from the high at 100. In Figure 2, once the low point of decay is known, we can apply the Fibonacci growth ratios to the 62 point decline and project an advance from the retracement low price at 38 to about 100 (100%) or 117 (127%) or to 138 (162%).

For Fibonacci Retracements you always base your forecast from the measure of one swing or one leg of the swing if it's a complex pattern. For the Decay Retracement the swing was from 0 - 100. The Fibonacci Retracement was 62%. For the Growth Retracement the swing was from 100 - 38. We applied the 100%, 127% and 162% growth ratios to that 62 point swing to project future price targets.

That's two applications of Fibonacci Retracement ratios for financial forecasting. These applications occur frequently enough across all price levels and time frames to have genuine forecasting value.

Fibonacci Retracements have one more application. We use them to create what we call the "Death Zone." In Figure 2 we used the Growth Ratios to project likely targets for what we believed was the beginning of the next upleg in the direction of the major trend. Needless to say things don't always work out as planned. From experience with the major stock indexes we never take a breath or start imagining what wonderful forecasters we are until the new upleg has safely cleared the Death Zone. The Death Zone narrowly drawn is the 62% - 79% retracement zone measured from the low point of the decay phase. In this case it would be the 76 - 87 price area (see Figure 3). We call it the Death Zone because this is where many promising new swings die an early death. A broader application of the Death Zone has it from 50% - 79%.

The corollary application of the Death Zone Retracement is that any Decay Retracement that exceeds the 79% retracement level immediately becomes suspect as the start of a major change in trend and not a pullback as first believed. Under most pattern recognition methods, including Elliott Wave, retracements up to 100% of the prior swing are acceptable without causing a change in outlook. That's OK too. But we never, never take a suspected Decay Retracement that exceeds the 79% level as a normal event that can be ignored with impunity. Maybe this would be the time to lighten up on usual positions size when making the reversal trade off the suspected Decay Retracement low. All these examples cover retracements of a bull move. The exact same principles apply for bearish swings.

Fibonacci Retracements are the most common application of Fibonacci techniques to trading in any market, but retracements are not the only Fibonacci technique, nor are they the most powerful. Limiting yourself to retracements is like writing a novel and limiting yourself to using only 1/3 the alphabet. The real power of Fibonacci is in Parallel Projections and Expansions. We show you how in our ebook Using Fibonacci Ratios to Forecast Pice and Time. We also show you a secret and simple technique to figure out in advance which Fibonacci cluster is likely to be the change in trend.

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