The first step to drawing Fibonacci fan lines also involves drawing a trendline between two extreme points, which are basically a swing high and swing low of a recent move. Then an “invisible” vertical line is drawn through the second extreme point. Three trendlines are then drawn from the first extreme point so they pass through the invisible vertical line at the Fibonacci levels of 38.2%, 50.0% 61.8% and 78.6%.
The Fibonacci fan lines can then be used to estimate support levels or potential reversal zones. Fibonacci fans are also useful to measure the speed of a trend’s movement, higher or lower. The more steep the fan, the faster the trend.
“Fanning out” (below) shows how prices in the S&P 500 found support and resistance at the fan lines. As soon as S&P 500 prices move below a Fibonacci fan line, price falls until the next Fibonacci Fan trendline level. Because of this, traders expect Fibonacci fan lines to serve as support for uptrending markets.
The chart of the S&P 500 (CME:SPM14) shows an uptrend that retraced to the 38.2%, 50% and 61.8% Fibonacci fan lines. These points are marked by blue circles.
In “Euro bounce” (below), we can see how these lines might be used to manage a trade, even when the odds are stacked against you in the form of a strong counter trend. This euro/dollar currency pair daily chart shows how long trades might be initiated after prices move through the 38.2% line and continue through the 50% retracement level. Once price resumes its drop and touches the 38.2% again, a low-risk entry is taken with a stop loss of a close below the 38.2% line. We target the 50% and 61.8% line. The targets were achieved. Note that this is meant as an illustration of the technique. It is not advisable to trade against the prevailing trend.