I hear a lot about Fibonacci levels, Murrey Math lines, and similar levels-based tools in trading. People who use them swear by them, and people who don’t laugh at them. The usual response of skeptics to levels in trading is, “if you draw a line on a chart, eventually the market will hit it,” flippantly dismissing the entire subject.
This argument is illogical, and most importantly, not true. Numbers *are* important, as any student of mathematics will tell you, and in mathematics as in trading there’s no such things as a coincidence. I am reminded of the answer to the famous question “Why is 196,884 = 196,883+1 so important?” This is yet another case in mathematics that people dismissed as coincidence, until proven wrong yet again. As Mr. Sheydvasser says, “Mathematics has very few coincidences. If you see a coincidence, that usually means that there is something larger that is hiding in the background that you just haven’t figured out yet.”
Anyone who has looked into Hurst Cycles or Fibonacci levels has got to admit the truth that the market isn’t random. The usual argument that the market is a never-ending balancing act between buyers and sellers doesn’t hold water when the market is subjected to rigorous mathematical scrutiny.
Consider this chart of the emini Nasdaq from Friday (right click on the image and select “open image in new tab” if you can’t see the whole chart):
You will notice that over the past 16 days price action has come down to the reversal line, bounced off, then headed to the overbought line, and turned down on Friday. The chart formation on the 16th is called a doji and is a signal, combined with the culmination of the movement upward since the 6th, that the market is going to change direction – and it does, moving down on the 17th. All of this is predictable to those who know how to read a chart and how to utilize the proper tools. But where is the market going on Monday? To answer that question, we have to add in a third piece of information: the chart for Friday on a lower timeframe. What did the market do?
As we can see from the chart on Friday, price moved down almost all day long (pay close attention to the 89 EMA – the orange line on the chart). Fibonacci analysis predicted a downside target of around 4910 (78.6% pullback = 127% target, 61.8% pullback = 161.8% target) – the low on Friday was 4904.25:
I would suggest that price will pull back on Sunday evening/Monday morning to the 4922-4933 area, then sell off to around the 4886 area if the market pulls back 61.8%, or 4894 area if the market pulls back 78.6%. For a 50% or 38.6% (shallower) pullback, I’d expect a downside target of 4865 or 4856, respectively (261.8% levels):
For an excellent practical look at Fibonacci levels and trading, take a look at http://www.forex.com/uk/pdf/Fibonacci-guide.pdf – even though it’s for the Forex market, the principles apply to any market.