CURRENCY STRATEGIES

Fibonacci fan lines
Currency traders generally use Fibonacci percentages to determine standard horizontal retracement levels in trending currencies. Using these percentages to construct Fibonacci “fan” lines adds another dimension to this type of analysis.

BY CORNELIUS LUCA

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onitoring the health tous horizontal Fibonacci lines, there Leonardo of Pisa, an Italian matheof the prevailing are two other ways to apply the matician who introduced the Hindutrend is a funda- Fibonacci ratios for retracement analy- Arabic number series that would evenmental responsibili- sis: fan lines and arcs. We will focus on tually bear his name to Western ty for any trader. And while at times fan lines and compare them to the Europe in his work titled Liber Abaci you will benefit from such moves as standard horizontal Fibonacci retrace- (Book of Calculations) approximately the downtrend that occurred in the ment lines. eight centuries ago. dollar/Norwegian krone (USD/NOK) The Fibonacci sequence is a number in the fourth quarter of 2004 (see Fibonacci review series for which every new number is Figure 1), such relentless trends are the The Fibonacci ratios are named after the sum of the previous two numbers: exception rather than the rule. Even the strongest trends FIGURE 1 — STRONG DOWNTREND are typically subject to several Although currencies have a reputation for strong trends, the down move in the U.S. dolpullbacks or retracements lar/Norwegian krone in late 2004 is relatively rare; price trends are more typically inter(shorter-term countertrend rupted by periodic retracements, or corrections. moves). Many traders rely on Fibonacci numbers to deter7.000 U.S. dollar/Norwegian krone (USD/NOK), daily mine likely retracement price 6.900 points. The most popular of these so-called Fibonacci lev6.800 els are the ratios .382, .50 and 6.700 .618, or 38.2 percent, 50 percent, and 61.8 percent. 6.600 (Actually, 50 percent is not even a Fibonacci retracement 6.500 level, but it is bundled with 6.400 this group because of its high technical significance.) The 6.300 basic application of these per6.200 centages is that a market will often pause or correct when it 6.100 retraces 38.2 percent, 50 percent, and 61.8 percent of the Sept. 14 24 Oct. 18 28 Nov. 19 Dec. 13 most recent price trend. Source: DealBook FX 2 In addition to these ubiqui18 April 2005 • CURRENCY TRADER

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, etc. One of the primary properties of the series is that as it progresses, the ratio of any number and its preceding number comes increasingly closer to 0.618 — e.g., 55/89 = 61797, 377/233 = .61803, and FIGURE 2 — FIBONACCI FAN LINES FOR UPTREND so on. The Fibonacci ratio is found Like standard trendlines, Fibonacci fan lines represent support in an uptrending market. in, among other things, the However, although the fan lines touch some of the earlier price lows in the uptrend, they geometry of the logarithmic are not constructed by connecting these price lows. spiral found throughout Euro/U.S. dollar (EUR/USD), daily nature (in a snail’s shell, etc.). 1.3666 1.360 The ratio of the length of the arc to its diameter is 1.618, 1.340 which is the inverse of 0.618. Another natural form that 1.320 exhibits Fibonacci proportions 1.3040 1.300 is the double helix of the DNA molecule. 1.2846 1.280 Fibonacci ratios are used by both classic technical analysts 1.2652 1.260 and Elliott Wave practitioners. For example, Elliott Wave 1.240 adherents often project future price targets by measuring the 1.220 most recent trend and multi1.200 plying by a Fibonacci ratio. Sept. 21 Oct. 15 28 Nov. 23 Dec. 17 30 2005 Here’s a summary of some of Source: DealBook FX 2 the Fibonacci series’ interesting numerical relationships: (e.g., 55 and 144) approaches uptrend, or add 38.2 percent and 61.8 0.382, while the inverse percent from the low of the range to • The sum of any two calculate upside retracement levels for approaches 2.618. consecutive numbers in the series a downtrend. equals the next number. For example, if a currency pair ral• After the first four numbers, Plotting Fibonacci fan lines the ratio between two Figure 2 shows Fibonacci “fan lines” lied from 1.5000 to 1.7500, the move is consecutive ascending numbers applied to an uptrend in the Euro/U.S. .2500 and the 38.2- and 61.8-percent approaches 0.618, which is a dollar (EUR/USD) uptrend. These retracement levels would be 1.7500 common retracement percent lines are drawn by connecting the sig- (.2500*.382) = 1.6545, and 1.7500 nificant high or low that starts the (.2500*.618) = 1.5955, respectively. The used by traders. • As the numbers rise, the ratio trend with the key Fibonacci retrace- Fibonacci fan lines would connect the between two consecutive ment levels for that trend move: You low price of 1.5000 to these two descending numbers approaches measure the range between a signifi- retracement levels. The 50-percent 1.618, which is the inverse of cant low and a significant high, then level is usually included with these deduct 38.2 percent and 61.8 percent two ratios. 0.618. The primary advantage of Fibonacci • The ratio between every other from the high of the range to calculate continued on p. 20 number in ascending order downside retracement levels for an

Fibonacci retracements lines have different characteristics than standard support and resistance lines.

CURRENCY TRADER • April 2005

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CURRENCY STRATEGIES continued

fan lines vs. standard horizontal Fibonacci retracement levels is the fans will provide earlier signals.

FIGURE 3 — CALCULATING FAN LINES Here fan lines and standard horizontal Fibonacci retracement levels are applied simultaneously to the uptrend. The horizontal lines are drawn by calculating the range from the trend’s low to high, and subtracting “Fibonacci percentages” of 38.2 percent, 50 percent and 61.8 percent of that amount from the high. The fan lines are drawn by connecting the low price to these three retracement levels.
Euro/U.S. dollar (EUR/USD), daily 1.3666 1.360

Combining fans and horizontal retracement levels

Let’s take a look at both the Fibonacci fan lines and hori1.340 zontal retracement lines in Figure 3. In early January, 1.320 1.3040 notice how the pair tested 1.300 both the 38.2-percent fan line 1.2846 and the 38.2-percent horizon1.280 tal retracement lines. Price ini1.2652 tially bounced off the horizon1.260 tal line and followed the fan line upward for a few days 1.240 before turning lower again. 1.220 Retracement lines, whether fans or horizontal, behave dif1.2026 1.200 ferently from standard sup28 Aug. 31 Sept. Oct. 20 Nov. 23 Dec. 27 2005 port and resistance lines, Source: DealBook FX 2 which are supposed to hold price. When they break, the market is expected to fall (when sup- qualities for a longer time. They es below the first (38.2-percent) fan port gives way) or rally (when resist- behave more like magnets, either line, expect that line to change into a attracting or repelling prices. For resistance level. This means the 50-perance breaks) further. By comparison, Fibonacci lines tend example, in the case of projecting cent fan line will turn into support, to retain their support or resistance retracements in uptrends, if price clos- and these two lines will provide the boundaries of the next trading range. FIGURE 4 — BREAKING THE FINAL FAN LINE The 50-percent line is generPrice paused around the 50-percent fan line but forcefully (and simultaneously) broke ally considered to be the through the 61.8-percent fan line and the horizontal 50-percent retracement level. strongest retracement level. If it also gives way, it will turn Euro/U.S. dollar (EUR/USD), daily 1.3666 into resistance and the next 1.360 fan line (61.8 percent) will 1.340 become the third support level. This is the last line of 1.320 defense for the uptrend; when 1.3040 broken, it signals the uptrend 1.300 has ended. 1.2846 This kind of analysis aug1.280 1.2652 ments standard horizontal 1.260 Fibonacci levels; look for points at which the two 1.240 approaches indicate similar retracement levels. 1.220
1.2026 2004 31 Sept. Oct. 20 Nov. 23 Dec. 27 2005 28 Feb. 1.200

Following the percentages
Let’s test these concepts on the evolving EUR/USD price
April 2005 • CURRENCY TRADER

Source: DealBook FX 2

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FIGURE 5 — CONVERGING FAN LINES

action. Figure 4 shows the curIn addition to the existing fan lines, a second set of fan lines is added to gauge potential rency pair peaked in lateretracements of the new downtrend. December 2004 and then made Euro/U.S. dollar (EUR/USD), daily an aggressive six-day decline 1.3666 1.360 in early January. It then hit the previously discussed double1.340 support level. 1.3289 Note also the magnet-like 1.3182 1.320 quality of the 50-percent mid1.3076 1.3040 dle fan line, which in this case 1.300 overlapped with the 38.2-per1.2846 1.280 cent horizontal Fibonacci line. 1.2652 The closings around and below 1.260 the middle line suggested the 1.2730 next trading range for 1.240 EUR/USD would be between 1.220 the 50-percent and the 61.8-percent fan lines. However, it took 1.2026 1.200 only two days of aggressive declines to challenge the final 2004 Sept. Oct. 20 Nov. 23 Dec. 27 2005 28 Feb. fan line, which also proved to Source: DealBook FX 2 be the weakest of the lot. In this case, traders could In Figure 5, the first set of fan lines retracement levels, and the two methuse these various lines as possible tar- is applied to the major uptrend and the ods used in conjunction can identify gets for profit-taking on short posi- second to the secondary downtrend stronger support and resistance levels. tions opened after the currency had (countertrend) on the daily EUR/USD Also, because the marketplace has yet apparently peaked. chart. The intersections between the to use this method much, fan line levfan lines going in divergent directions els will generally not be subject to Using other inputs can provide confirming support and stop-loss hunting as standard lines. Don’t ignore additional technical resistance areas. information when performing this Fibonacci fan lines can offer earlier For information on the author see p. 8. type of analysis. For instance, immedi- signals than standard horizontal Questions or comments? Click here. ately after the sharp down move in January (when the currency pair Related reading bounced off the 38.2 horizontal support level), price made a candlestick "The Fibonacci Swing Filter" Active Trader, February 2005 pattern called “three methods,” which This approach creates an adaptive trading system that adjusts to the consists of three days of countermarket's behavior by measuring price swings in terms of Fibonacci movement to the existing downtrend. retracement percentages. (This also could have been interpreted as a bear flag.) "Trading with synchronicity" Active Trader, January 2003 The second consolidation around A trading approach that combines Fibonacci price analysis with time analysis the 38.2-percent horizontal line formed to better identify potential reversal points. another shorter-term bear flag, and once it started to unfold, it provided "Candles in the zone" Active Trader, June 2002 additional confidence in a bearish outThis candlestick pattern strategy uses Fibonacci ratios to identify changes in look. trends and counter trends.

Using more than one set of fan lines
Generally, traders should use only one set of fan lines if there is only one trend being analyzed. However, if more than one trend is present, additional sets of fan lines can be applied.
CURRENCY TRADER • April 2005

"Technical Tool Insight: Fibonacci ratios" Active Trader, April 2002 A primer on Fibonacci ratios and their trading applications. You can purchase and download past Active Trader articles at www.activetradermag.com/purchase_articles.htm.

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