From the September 01, 2006 issue of Futures Magazine • Subscribe!

Fibonacci ratio analysis

A common complaint about Fibonacci Ratio analysis from traders is “which ratio do you use?” Well, if you’re using only a single price leg to determine a market top or bottom, it can be an almost impossible question to answer. Take a look at “Following the retracement.” Price swing A-B completed at 1.1637, and then began to climb higher searching for the retracement level “C” to ultimately reverse trend back down. The market traded up through 0.382, 0.500 and then to the 0.618 retracement level, which finally did the trick. But how could you have known this ahead of time? By considering the price swings within retracement leg “B-C”.

Ratio analysis can not only tell you how far a market could retreat, but also how far a market might advance. Consider price swing “V-W,” which advanced 686 points within “C”. You multiply 686 points by 1.618, projected higher from “X” equals 1.2942 at point “Y.” Remember that 0.618 retracement was at 1.2892. So now you have confluence within a small 40-point zone and confidence that the 0.618 retracement will hold.

So what next? Currently, EUR/USD is retesting the 1.29 handle for the third time and taking into account the Fed is almost at the end of its tightening cycle, we have to consider a retracement deeper than 0.618. The 0.786 retracement aligns with 2.00 projection of “V-W-X” at 1.3233 and 1.3202, respectively, at “Z.” So now we have confidence in our second, 30-point target zone of Fibonacci confluence.

Todd Gordon is a currency strategist and trader at Forex.com, a division of Gain Capital Group. Gordon, a Level 2 chartered market technician, also teaches seminars on using technical analysis in the Forex market.

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