Fib retracements are sort of after the fact analytical tools but I find them helpful to apply when the market has made large moves, such as the OCT to DEC move. The best quick explanation in book form if you can borrow it from someone or simply go to Borders or Barnes and Noble with a pen and paper and take notes is Muprhy's Technical Analysis of the Financial Markets.
Long story short, is that the theory is that when the market makes a large move there will naturally be retracements. A mathematician (whose name by the way was not Fiboncacci) discoverd a math series and found this numerical pattern in nature using the number sequence 1,1,2,3,5,8,13,21,34, etc where each number is the sum of the previous two.
If you take the % differences between the average numbers you will see that a number to the right is about 62% greater than the number to its left. I.e., 34 is ~62% greater than 21. And going the other way, right to left, the numbers decrease by ~38%. I.e. moving from 34 to 21 is a 38% decrease.
Technical analysts applied these numerical patterns to trading and found or claimed that stock moves will retrace back in these same dimensions. In other words a move higher will retrace back 38%. If you look at the FIB sequence and move two places from right to left, the retracement is about 62%, in other words going from 34 to 13. Expanding it out, the theory also adds that large moves will retrace about 50% of its gain before moving higher again.
So based on these patterns, the fib retracements claim that a move upwards or downwards will retrace and the retracement levels that are most likely based on Fib seuqences are 38% and 62% of the high or low and many people also use 50% as a significant level.
Therefore on a large move, such as the OCT to DEC move in SPX, charting programs like Tradestation where I posted the charts, lets you add the FIB retracement lines to visualize potential retracement points. Of course this is very subjective and others add in other % retracement lines, but if you look at large price moves and add the fib retracements in, they tend to pan out more often than not.
Therefore, they serve as good additional guidelines to look for retracement points and for support and resistance levels.
Hope that helps a bit although I may have muddled the Fib definition....
Quote from nlslax:
Coach,
This is slightly off topic, but I noticed you use Fib retracements as part or your trading strategy. Can you give me/us a quick overview and then suggest where to go to learn more? I did a search on ET but didn't come up with much. Maybe it's my spelling...
Thanks again.
