As we covered in our first Fibonacci blog, which you can read here, Fibonacci Analysis is a functional theory that can be applied to the stock market to help you quickly highlight where areas of support and resistance are most likely to be found on your stock chart. We also learned there is an inherent structure to all things, and the Fibonacci tool will help you find those areas of structure, commonality, and confluence in the stock market. However, there are a few mistakes that you will want to avoid when using the Fibonacci tool and drawing retracement lines in your analysis.
One of the main things to remember when drawing your Fibonacci lines is staying away from becoming fixated on extreme price highs and lows for your Fibonacci ranges. After all, history does tend to repeat itself, so make sure to use historical pivot points to support current Fibonacci range placement. Next, remember to always draw from right to left while taking note of significant gaps, price moves, and long day candles. Finally, remember using the Fibs tool is a balance of creative and analytical determinations, so make sure to keep your analysis balanced between hard logic and artistic sensibilities as we use the tool to determine areas of confluence.
Confluence is defined as the flowing together of two streams into one stronger and larger stream. The same principle applies to the stock market when using the Fibonacci Retracement tool. When drawing out multiple ranges, there will be areas where Fibonacci ratios are found in tight clusters or overlapping each other. These clusters are areas of confluence, and they will help you to narrow your focus.
To find these confluence zones, you need to draw multiple Fibonacci ranges beginning with the same point of origin and ending on different but relevant price swings. Let’s do this by drawing some Retracement lines on APPL in the examples below.
Here is our first set of retracement lines which provide the broadest framework.
Here is our second set of retracement lines which starts to reveal some confluence amongst the data. Note that Confluence literally brings the grid into focus and gives you confidence in your selected ranges.
And here is our third set of retracement lines which confirms an area of confluence on the charts. At this point, you will want to set your ratio lines to thick and your Confluence marker to thick. If they overlap, consider it confluence.
Finally, note the ratio clusters and delete your Fib lines.
Confluence was found at $63.63.
In the example above, we found a strong point of confluence at $63.63. So statically speaking, there is an excellent chance something will happen with Apple when it hits this price point. If the confluence line is respected, it can form a line of resistance and be the start of a bearish trade. Still, even better, if the price point of Apple moves past or disregards the confluence line, it is a significant sign that the framework of the stock is changing. The upcoming bullish move can be very profitable. As seen in the following screengrab, Apple broke above $63.63 and took off.
Along with your support and resistance lines, Fibonacci analysis will highlight areas of confluence on your candlestick chart. These are areas where something statistically important can happen, such as a price reversal. After all, Fibonacci analysis is a tried and tested tool for your trading toolkit and is excellent at finding the hidden areas of confluence. So what are you waiting for? Give the Fibs tool a try by experimenting with retracement drawing, and watch it open another door to your trading analysis.