Last weekend, Bursa Marketplace organized a free event and the Fibo event attracted me since my Fibo skills are merely elementary and all I understood was ‘Fibo = a bunch of horizontal lines’.
But indeed this was a great course for me to discover a new technical analysis method and I’ll try to share the important parts. As you can see this is a crash course we will do a simple intro and jump straight into applying via step 1, 2, 3, etc…
It was observed that many things in nature follow a natural sequence which can be represented by the the Fibonacci sequence. Things such as a formation of a spiral shell can be explained or the famous drawing by Leonardo Da Vinci on the proportion of the human body which follow a Fibonacci sequence.
I’m not going to go into details on this buy you can visit this site for more info.
What’s important is these sequence.
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, ….
The sequence above isn’t some random number but its actually a sequence of where the first two number are summed up with a starting point of 0, 1,… The sum of 0 and 1 equals 1 followed by 1 and 1 which equals 2, 2 and 1 which equals 3 and so on…
So how do you translate these random numbers into the candlestick charts?
A week has 5 trading days.
A month has roughly 22 trading days.
A quarter has roughly 60 trading days
A year roughly has 250 trading days.
The number of trading days are close to the Fibo sequence of 5, 21, 55 and 233. Since that’s the case we can build our model of Simple Moving Average based on the Fibo sequence number forming SMA5, SMA21, SMA55 and SMA233.
Depending on which time frame you are looking at, you need to modify your SMA based on it. But today, we are more interested in medium term trading with daily candlesticks.
With daily candlesticks, we are more interested with SMA55 and SMA233 since quarterly reports alters a stock’s direction and the long term average of 1 year is suitable to gauge how the stock is performing.
Step 1: Generate a chart with SMA55 and SMA233
With that, we generate a chart similar to the one below.
Step 2: Look for Crosses
Next is to look for Golden Cross or Death Cross within the chart after adding both SMA55 and SMA233.
Investopedia ‘Golden Cross’
The golden cross is a bullish breakout pattern formed from a crossover involving a security’s short-term moving average (in our case SMA55) breaking above its long-term moving average (SMA233) or resistance level. As long-term indicators carry more weight, the golden cross indicates a bull market on the horizon and is reinforced by high trading volumes.
Investopedia ‘Death Cross’
A death cross is a crossover resulting from a security’s long-term moving average breaking above its short-term moving average or support level. It is so named due to the shape created when charting the activity and its association with a downward market trend. As long-term indicators carry more weight, this trend indicates a bear market on the horizon and is reinforced by high trading volumes. Additionally, the long-term moving average becomes the new resistance level in the rising market.
Basically after a Golden Cross happens, you would want to do ‘BUY’ trades. Similarly after a Death Cross happens, you would want to do ‘SELL’ trades. Basically you wouldn’t want to be a hero trying to buy the lowest point as you are likely to get batched up rather than be lucky most of the time.
Going back to CIMB’s, a Golden Cross just happened and we already can determine that the BUY calls should already be coming in and active in your mind!
Step 3: Look for impulses and corrections
Generally, impulses looks something like in the picture below. The wave 1 up is an impulse while wave 2 down is a correction. The impulse and correction is only true when the range of wave 2 is less than wave 1.
In the case for CIMB in our example, the Fibo horizontal lines can be drawn from the bottom very bottom of the 1st impulse to where it ends represented by the up arrow (start) to down arrow (end).
Note that the 1st impulse is determined by the 1st Golden Cross that occur. Meaning the Golden Cross that happened in mid-September already gave us the buy signal and our job is to find the 1st impulse which is usually the period of time before where the Golden Cross happens. Obviously we can’t determine where our retracement line drawn should stop until the first correction happens. In my opinion, I believe this is the limitation of this model and should never be used to fish the bottom.
From the chart below, I’ve determine my 1st correction as the price of CIMB from 4.86 to 4.57.
With that, the Fibonacci retracement lines are drawn and you can see that it immediately hit the 5.04’s resistance on last week’s close. Those retracement lines on the chart are good reference points to buy or profit take depending on which trade you have or going to initiate.
At the point of writing, CIMB currently trades at 5.08 which meant that if the strength persist it would hit 5.15 in no time and 5.04 is had became the new support level. In this case, we can conclude that 4.7o is a good entry point when a correction happens.
What’s with the Average True Range indicator?
As you can see in the chart below, ATR was set at 60 periods (a quarter) and at the current moment the ATR recorded for CIMB stands at 0.085.
The number 0.085 meant that it is the average range that CIMB trades for the last 60 days.
ATR does not determine which end the market would breakout but when the day’s range exceeds the ATR number, it is likely that the follow day’s market would follow.
So if you’re still holding to CIMB last Friday and in a dilemma either to take profit or hold on hoping to break the 5.04 resistance, you can refer to ATR. The ATR was around 0.085 and the day ended with CIMB gaining 0.11 which is more than ATR.
In this case, you can hold on since the probability for another run up is higher than to stop at that resistance level. It doesn’t confirm but based on calculated risk, the odds are on your side. Coming into today’s trading session, it seems to be correct that CIMB breached the 5.04 resistance and probably reaching the 5.15 resistance very soon.
Summary of Steps
Step 1: Setup SMA55, SMA233
Step 2: Determine the Crosses
Step 3: Determine the impulse to draw the Fibo retracement lines
Step 4: Confirm trend using ATR (to break resistance/support or remains weak and retrace)
Step 5: Try to determine these before market closes as this is where the day’s candle begin to form and recorded
I did not talk about how the percentages are determined or how these numbers are sp strong to be used as reference. You should read why people use these numbers as it the series eventually end up in what they call a ‘Golden Ratio’
Visit here and read about Golden Ratio and why these numbers prove a point to be used as reference