However, in terms of forecasting, if an important index or sector does play its hand, the trader can leverage that information and gain a different type, but still excellent, of edge. The banking index BKX gives us such an example (see “Banking on a bounce,” below). It also shows us that a retracement does not need perfect precision to work.
The BKX low in 2009 was 17.76 with a peak at 58.81 in April 2010. The range is 41.05 and 0.618 of the range is 25.36. Subtract 25.36 from the 58.81 high, and we get 33.45. The low on Oct. 4, 2011, was 32.56, which is less than a full point off. As it turned out, that low was also in the 161 day trading window to its February 2011 peak.
If a retracement can cluster with a Fibonacci time window, it has a much greater chance of working out. Time is an important piece of the puzzle, and markets will respond to Fibonacci (and other) time windows with regard to both trading and calendar days. In terms of leverage and banks, if an important sector turns, chances are the overall market does as well.
Fibonacci retracements also can work in highly charged emotional markets. An example materialized at the emotional turn in August when the Nasdaq futures bottomed. The price action bottomed and rallied 159 points in about 15 hours. It then dropped approximately 99 points in roughly two hours. How does a trader navigate this kind of volatility? A close look at the action shows the retracement leg stopped going down at exactly 61% of the first move off the bottom. There is no other technical explanation of why the pattern turned where it did.
Because of hits like these, many traders will rely on the Fibonacci retracement to target intraday turns. While the trader will get some successes overall using retracements as intraday trading targets, the analysis has more misses than hits. For targeting intraday turns on charts such as E-mini stock indexes or forex, Fibonacci retracements are not as effective. Retracements tend to work better on larger time frames.