Finding Significant Support and Resistance

This chapter provides a guide to detecting when support and resistance levels are
exhibiting Fibonacci characteristics and their importance. Resistance and support
at pivot points are also explored.
FIBONACCI LEVELS OF SUPPORT AND RESISTANCE
Beyond basic geometric measures of support and resistance, there are hidden factors involving
psychological forces and patterns in the market that enable the trader to project
future levels of support and resistance. Most famous among these forces are Fibonacci
levels.
Fibonacci ratios are mathematical patterns of sequences that are expressed in many
ways. There are innumerable references to the universality of Fibonacci numbers—a
quick Google search reveals over 1,230,000 citations. The Fibonacci sequence describes
key ratios from growth in plants, human anatomy, and so on. The forex application is to
price movements, which appears to realize Fibonacci ratios. This is particularly obvious
on larger time frames such as weekly, daily, and 4-hour time charts. A large move from
a low to a high is often followed by an attempt of the price to move back or “retrace”
the original move. The profit taking will cause the price to give back a proportion of the
move and then rest at support or resistance. These areas of rest are Fibonacci points. For
example, let’s look at a chart showing a price move on the euro–U.S. dollar (EURUSD)
weekly chart .

We can see that the EURUSD made a low at 1.2478 and then proceeded to form a high
at 1.3374. Once this move was completed, the trader can use a Fibonacci (Fib) graphic
tool, which is available on all platforms to draw a Fib line. Since the price started from
the low, the Fib tool assigns the 100 percent level to this origin point. The best way to
interpret this is to think of the price going all the way back home to where it started.
It would achieve a 100 percent retracement. Once the low and the high are connected,
the Fib graphic tool draws the lines and projects it out. Notice that these Fib lines are
extended into the future. The trader doesn’t know if the price will get there! The trader
makes the assumption that if the price is able to get to a Fib level, it will experience
strong support or resistance. Also, if the price is able to probe a future Fib level but fails
to go through it, the trader can make a reliable assumption that there is key support at
that level.

Let’s get back to the chart. The price moved from the low of point A to the high
of point B and then proceeded to retrace or fall back. What did it do? It probed the
50 percent line but failed to close below it. It was as if it were performing a Fibonacci
dance scripted in advance. But a chart using a 15-minute U.S. dollar–Swiss franc (USDCHF)
chart follows a Fibonacci pattern, and we see the price falling and trying to retrace
but failing at the key 38.2 percent fib line (see Figure 11.2). Experienced traders would
be ready to sell this pair upon these failures.
Figure 11.3 shows a day chart of the EURUSD and another use of Fib lines. The
EURUSD completed a move from a high at 1.3293 to a low at 1.2854. Remember, only
after it completed the move would a trader be able to put on the Fib levels. The Fib levels
then projected out the key Fib lines, which are the projected areas where retracement
might occur. We can see that the price moved during a two-day period to point A (the
38.2 percent level) and then failed to close above it. The EURUSD proceeded to move
into a three-day trend down nearly 150 pips. It then moved back up and actually went
near the 50 percent Fib level but returned below it and proceeded to fall over 100 pips.

What is instructive here for the trade is that if the trader were looking to sell, knowing
in advance where the Fib levels were meant, while the price was going above point A or
B the trader would look to put on a sell trade when the price fell below the Fib lines
(of course, confirmed, as we shall see with other indicators). Point C is interesting. If
the price falls to point C and stops, the trader with a buying strategy would focus on the
price action at this point because stopping at a key Fib line means that support is strong.
In contrast, if the trader were looking to sell, the price would have to go below the Fib
level at point C to prove it had the energy to keep going.
Let’s look some more. In the USDJPY 4-hour chart (Figure 11.4), we see the yen
strengthening and probing a key Fib line. Traders looking to sell would be watching
this chart. The 4-hour period is particularly important because a 4-hour trend direction
represents a great deal of money flowing. Consider the fact that over $2 trillion per day
is transacted in forex.

Fib lines should not be treated as predictions of what the price will do. They are
maps of potential support or resistance. They are areas where great care should be taken
by the trader. Rest assured that any professional trader knows where the key Fib levels
are. Perhaps because these levels are projected and therefore known in advance, they
generate a self-fulfilling process and increase in importance. But the phenomenon of Fib
behavior is real and should never be ignored. Take a look at the Fib behavior of the
EURUSD in response to the September 11, 2001, terrorist attacks and in response to the
July 5, 2006, London train bombings.




By ABE COFNAS