Fibonacci profit objectives

Stocks & Commodities V. 7:8 (267-268): Fibonacci profit objectives by Joe DiNapoli

Fibonacci profit objectives by Joe DiNapoli

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nyone who has been involved in the market for long has probably heard about Fibonacci numbers

and ratios. We know they somehow mysteriously affect the market; however, most of us resist trying to understand how they work. I resisted because I thought that Fibonacci numbers, wave analysis and related systems were very difficult concepts to learn. Eventually, my desire to better understand the market and to win bigger overcame my prejudice. I quickly discovered that applying Fibonacci techniques to the market is not very difficult, and that a trader does not need to be an Elliott Wave technician to apply Fibonacci concepts. The Fibonacci number series (1, 2, 3, 5, 8, 13, 21, etc.) and the resulting Fibonacci ratios (0.146, 0.382, 0.5, 0.618, 1.0, 1.382, 1.5, 1.618, 2.618, etc.) are the heart of Fibonacci analysis. My technique of using Fibonacci expansion analysis uses only three ratios: 0.618, 1.0 and 1.618. With these three ratios, I calculate logical profit objectives. I can ignore most of the other ratios, as well as the entire number series from which those ratios are derived. Profit objectives I use three simple equations to establish logical profit objectives, where A, B and C (Figures 1a and 1b) are specific points in a market move. The first objective is the contracted objective point (COP). It utilizes the Fibonacci ratio 0.618: COP = 0.618(B–A)+C

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Stocks & Commodities V. 7:8 (267-268): Fibonacci profit objectives by Joe DiNapoli

FIGURE 1a:

FIGURE 1b:

FIGURE 2:

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Stocks & Commodities V. 7:8 (267-268): Fibonacci profit objectives by Joe DiNapoli

The second objective is the objective point (OP), which uses the Fibonacci ratio 1.0: OP = B–A+C The third objective is the expanded objective point (XOP), which uses the Fibonacci ratio 1.618. XOP = 1.618(B–A)+C This simple set of equations has allowed me to calculate the major turning points in a variety of markets—days, weeks, sometimes months ahead. In Figure 1a, point A marks the beginning of an up move, B marks the highest high of that move and C marks the lowest low following point B. In Figure 1b, point A marks the beginning of a down move, B marks the lowest low of that move and C marks the highest high following B. Once all three points have been located on a bar chart, their respective values can be entered into the equations, and all three profit objectives can be quickly determined. Trading strategy The strategy of Fibonacci expansion analysis, then, is to locate points A, B and C on a price chart, determine the values of each point and enter the values into the objective point equations, producing three different profit objectives at varying distances from point C. Once you have located the three profit objectives, your strategy for taking profits can include any combination of the objective points. You might choose to take all of your profits at one objective point, for example, or if you are holding a multiple-contract position, you could peel off contracts at each objective point. As you work with the concept you will likely develop other workable strategies.

An important rule...is to use objective points primarily for exiting established positions. Three targets, or logical profit objectives, can be calculated from any ABC market swing, whether the thrust is up or down, using intraday highs and lows. A software program I designed called Fibnodes can perform these calculations and a variety of others in a particularly effective format, but all you must have is a pencil to do the figuring or perhaps a programmable calculator. Profit objectives also can be located on a price chart with an architectural tool called a proportional divider or precision ratio compass. The resulting numbers are extended from point C in the same direction as wave AB. In Fibonacci expansion analysis, negative numbers are not recognized. It should be noted also that analysis does not use time to locate profit objectives. Figure 2 illustrates the potential for reaching price objectives at different times. It is possible for a wave that occurs after wave ABC to reach all three objective points after experiencing

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Stocks & Commodities V. 7:8 (267-268): Fibonacci profit objectives by Joe DiNapoli

a reaction at the previous profit objective. It is also possible that the first objective could be the end of the move. Note that, when using logical profit objectives, significant selling will be manifest at all three objective points in an up move, while buying will occur in a down move. You cannot be sure of the extent of the resulting reaction, only that the activity will occur. There's nothing wrong with exiting partial positions at each objective as it is met. An important rule to observe when using expansion analysis, however, is to use objective points primarily for exiting established positions. That way, you are always trading with the trend of wave AB and not against it. (A strategy of purchasing options against objective points is also acceptable, but more risky than flowing with the trend). After exiting a position, I usually wait for outright entry signals before taking new positions. Whether you use COP, OP or XOP as a profit objective, it is a judgment call that takes into consideration other tools in your technical arsenal—for example, overbought/oversold oscillators, strength and thrust of the move indicators, previous length of base, trend in the next higher time frame and volatility. Joe DiNapoli, president of Coast Investment Software, 8851 Albatross Dr., Huntington Beach, CA 92646, (714) 968-1978, is an active trader, seminar speaker and software developer. Excerpted with permission from High Performance Futures Trading: A Manual of Expert Systems and Master Strategies, Joel Robbins, Ed ., Probus Publishing Co., 118 North Clinton St., Chicago, IL 60606, (800) 426-1520.

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