stock market made a significant bottom in the beginning of October, and it

proved to be a very good time to be committing money to the market.

I have included an enlarged chart of the Dow Industrials to show the

price action at the 0.618 and the 0.786 retracements. As you study this, it I
important to notice how the Industrials acted after they hit these
retracements. In the case of the 0.618, projected at approximately 7890, the
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Dow Industrials continued to decline in the days after it hit this price level.
As for the 0.786, the Dow Industrials clearly found support.

The major Fibonacci retracements of the 0.618 and the 0.786 from the
prior year’s low proved very accurate in gauging the price action. The
0.618, which was just below 7900, was obviously “blown out” by a strong
sell-off. However, the Dow Industrials found good support at the 0.786 and
reversed nicely from this area. Even if you waited for a clear reversal, the
support at the 0.786 indicated that the Dow Industrials established a bottom
and that a new uptrend was in place.
These declines will happen again! The financial markets will provide
you with opportunities like this one in the future. When these situations
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occur in the future, you must realize their significance and take advantage of
these opportunities.
During the market’s decline in the fall of 1998, Disney also suffered a
serious beating. The stock was cut in half in less than six months. This
weekly chart illustrates the significance of the 0.786 retracement. The stock
reversed off the 0.786 retracement from a critical low in July 1997 at 17 3/4
(pt. X) to a high in July 1998 at around 42 1/2 (pt. A). Disney declined and
then reversed almost exactly at the 0.786. The 0.786 was calculated at 23
1/16. Disney declined to 22 1/2 (pt. B) and rallied over 15 points during the
next few months.

On the week Disney hit the 0.786, the price action clearly indicated a
reversal at hand. The reversal was confirmed, since the following week
started an uptrend that led to a nice rally over the following several months.
You might be wondering (again) how you would know to utilize the 0.786
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as an entry point rather than the 0.618. I have included an enlarged chart to
illustrate the price action at the 0.618 and the 0.786.

As you can clearly see, the stock sold off sharply past the 0.618,
which was projected at 27 1/4. On the week that Disney hit this number, the
selling was quite strong, as evidenced by the extreme price range. Such an
extreme decline is a warning sign that the Fibonacci projection is probably
not a good point to buy. At a minimum, when a warning sign is observed at
a Fibonacci number, you should wait one price bar. In this case, the stock
continued to decline the following week.
The stock did begin to reverse after hitting the 0.786 retracement. The
reversal was confirmed the following week, as the stock gapped up on the
open and finished with a bullish close. The reversal was confirmed further

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by the next week, when the stock broke above the previous two weeks' highs
and closed very strongly.
This is a great chart to study because the stock bounced almost exactly
off the 0.786 retracement. Such harmonic action is no coincidence, as this
example of Disney truly validates the use of Fibonacci numbers in gauging
price action.

Bearish 0.786 Retracement

The 0.786 retracement can act as a "last chance" resistance point
before retesting the previous high. It is a very key area because price action
that reverses from a 0.786 retracement of a prior high usually can indicate
weakness in the overall trend. Let’s look at the illustration.

When price action rallies, especially after a substantial decline, the

0.786 is an important resistance level. In my opinion, price action that can
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breakthrough the 0.786 retracement usually will retest the previous high.
However, if the price action can not rally above this point, the ensuing
reversal can be quite significant. Let’s look at some examples, as they will
clearly illustrate the concept.
The following chart of America Online is a fantastic example of
resistance at a 0.786 retracement. Although the stock exceeded the
projection slightly, AOL had tremendous difficulty rallying through this
retracement.

Despite the extreme volatility, AOL clearly reversed after hitting the
0.786 retracement. From the early April high at 175 1/2 (pt. X) to the
following low at 112 (pt. A), the stock bounced and reversed just past the

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0.786. The 0.786 retracement was projected at 161 15/16 and AOL reversed
after hitting 167 1/8 (pt. B).
This might have been a difficult execution to gauge. The day before
the stock reversed, it hit the 0.786 and even closed near the high of the day.
Also, on this day, the stock gapped up on the open several points. Since
these warning signs occurred at an important Fibonacci number, the trade
should have been avoided on this day. Despite this price action, the stock
could not follow through on the upside, and America Online clearly reversed
the following day.
When a stock can not continue its rally through the 0.786, as this
example of AOL demonstrates, you must regard this action as bearish. This
is especially significant, since the stock formed an extremely bearish
candlestick the day after hitting the 0.786. If the stock was going to rally
higher, the price action should continue to move up, forming higher highs
and higher lows. Also, another bullish indication would have been a close
above the 0.786 on the following day.
America Online could not continue its rally. So, if you waited a day,
the clear reversal bar would have indicated that the 0.786 was indeed acting
as strong resistance. Your patience would have been rewarded, as AOL
declined over 30 points in the next few days after the reversal occurred.
The chart on the next page of 3Com is another example of a stock that
sold off sharply after almost exactly hitting a Fibonacci retracement. 3Com
experienced significant resistance at the 0.786.
However, it is important to note that the stock did not reach the exact
0.786 retracement. 3Com reversed at 51 1/8, while the retracement was
calculated at 51 7/8. I would prefer to have seen the stock hit the 0.786
before entering a trade. But, this price action is so close to the retracement
that I would consider it valid. I am sure at this point your next question is:
how do you know? Referring to the chart, 3Com could not continue its
rally after falling 3/4 of a point shy of the projection. In fact, the stock
started to seriously break down several days after the reversal.
When a stock does not rally through a major Fibonacci retracement, as
this example of 3Com demonstrates, this should indicate substantial
resistance in this area. The stock moved sideways for over a month without
even challenging the reversal high. Even if you were still in the stock, the
major decline that occurred in the beginning of February 1999 would have
confirmed that the new downtrend was in place.

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0.786 Retracement Summary
In summary, the 0.786 is a very significant Fibonacci retracement.
When a stock is declining, it is a critical area for support before retesting the
initial bottom. When a stock is rallying and attempting to retest a recent
high, the retracement can act as significant resistance. The key to gauging
the 0.786 as a potential reversal point is to study the price action at the 0.786
ratio and assess the following move. The price action around the 0.786 can
provide substantial information regarding the potential future of a stock.
Although the 0.786 is relatively unknown in the investment industry, it is an
extremely effective gauge of a stock's price action.

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 9

1.27 Projection

The 1.27 is an important primary Fibonacci number for several

reasons. It is first area to examine after a stock has moved beyond a
significant previous point of resistance or support. In the case of a break
out, the 1.27 projection is the first area to either take profits or enter a short
position. In the case of a break down, it is the first area for potential support,
covering a short position or entering a long position.
The 1.27 is the square root of 1.618. Similar to the 0.786, the use of
the 1.27 has been popularized recently and it represents a critical projection
in many patterns. I believe the 1.27 is one of the most essential Fibonacci
numbers in the assessment of harmonic price action. Furthermore, the
existence of the 1.27 in harmonic patterns serves as a minimum requirement
for many trade set-ups to be valid.
Although the 1.27 ratio is not as well known as the 1.618 extension by
technical traders, reversals from the 1.27 occur as frequently. Using this
ratio will improve your ability to gauge price action and it will identify
excellent trading opportunities.

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Bullish 1.27 Projection

The bullish 1.27 projection is an important area to look for potential

trade set-ups. When price action breaks down past its initial starting point
(at X), the 1.27 projection is the first place to look for potential support.

Let’s look at some examples, as they will clearly illustrate the

importance of the number.
The following weekly chart of Texaco illustrates the 1.27 as a nice
area for support. Texaco reversed off almost exactly from this 1.27
projection. The 1.27 projection was calculated at 44 13/16, and the stock
reversed at 44 9/16. Also, Texaco reversed on the week it hit the projection.
This projection developed over a year in duration. After the stock
broke down past the previous low (pt. X), Texaco accelerated on the
downside. Despite this decline, the stock bounced sharply off the 1.27
projection.

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