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Great Examples of Fibonacci Analysis–Part 4
01/21/2009 9:50 am EST
Fibonacci fans are very similar in concept to Fibonacci retracements, and in many ways, they are used in the same way. Both are effective tools for identifying support and resistance levels, entries and exits, and stop and price target levels. Ultimately, you would try both and decide which works best for your trading style and analytical preferences.
How Fans and Retracements Differ
1. Fans are more useful when a currency is trending, because the projected lines follow the trend diagonally, rather than horizontally, on the charts.
2. Fans will often stay valid longer than a Fibonacci retracement analysis for the same reason.
How Fibonacci Fans Are Constructed
The Fibonacci fan uses the same primary ratios of 38.2%, 50%, and 61.8% that were discussed in earlier sections. The Fibonacci study is applied to the high and low of a trend in the same way that a Fibonacci retracement is placed. The diagonal fan lines are based on an imaginary vertical line drawn from the top to the bottom price levels of the trend.
The fan lines are drawn from the bottom of the trend through the vertical line at its 38.2, 50, and 61.8% points. In the chart below, you can see how this would look if you could see those lines drawn on the chart.
Each level of the Fibonacci fan acts as support and resistance line and is very useful when the market is trending, as it can point to the trend for a long period of time. The lines create candidate support areas that can be used to enter a new trade in the direction of the existing trend. They are also useful as a warning for potential resistance areas. That is useful because it can be used as a trigger to tighten up risk control or even to take some profits off the table.
How to Draw Fans
The process for drawing Fibonacci fan lines is similar to Fibonacci retracements, but because they accommodate the trend, they may have to be adjusted less frequently.
First, identify the trend by anchoring the Fibonacci fan study to the top or bottom of the trend you are identifying. In the example below, we will use the top of the USD/CHF in June as the first anchor point for a short trend on the pair.
The bottom that occurred on August 6th would have worked well as the second anchor for our Fibonacci rays. You can see the anchors and the subsequent areas that may have been great new opportunities to short the pair at resistance or cover some risk at support. By mid-August, the market had broken through the bottom fan support level and was beginning to climb. So in this case, our fan showed us accurately the proper resistance level, and would have given us good entry points.
Here are a few tips that will help you better understand how Fibonacci fans work, and how you can begin experimenting with them in your own trading:
How to Anchor Fans
Like a Fibonacci retracement analysis, determining where the tops and bottoms of the trend are is somewhat subjective. However, Fibonacci rays, like retracements, can tolerate a fair amount of variation as long as you are picking significant highs and lows.
Here is an example of the same USD/CHF chart, but rather than anchoring the bottom of the analysis with the August lows, an analyst might have selected the significant bottom on November 23rd. As you can see, the fan's lines were still very helpful in identifying the December and February tops. Pretty neat, eh?
Other Things to Consider:
When to Adjust the Anchor Points
Because fan lines are drawn to accommodate a trend, you don't "have" to move the anchor points until the trend moves outside-either above or below-the range of those lines. In the video, we will look at a specific example of this kind of situation. Quite often, the study will stay intact as long as the trend itself lasts.
Entry Points and Profit Targets
The distance between fan lines becomes wider the further the trend extends. Be aware that this makes developing a consistent rule of thumb for entry points and profit targets more difficult than it is for Fibonacci retracements.
Don't Get Too Steep
Not every analytical method will work in every situation. Very steep trends are not very conducive to this kind of analysis. In the chart below, you can see the effects of this problem when the trend used to anchor the Fibonacci fan study was a result of a very fast-moving market. The market almost immediately moved outside the range of the Fibonacci fan study and limited its usefulness.
Alternatively, very fast trends or corrections can be ideal situations for a Fibonacci retracement study to find potential areas of support or resistance. As you can see in the chart below, we could have gleaned some very valuable information from a retracement study in the same situation.
For more information, click below to watch the video:
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