Trading based on Fibonacci retracements is a good way to make money in the stock market. It is my belief that a lot of the computer high frequency trading takes place due to Fibonacci algorithms. Smart investors and institutions have also traded for many years with Fibonacci retracements as stock buying entry points.
Now, how exactly do the Fibonacci numbers relate to stock trading? First, the decimal forms of Fibonacci numbers are used as I discussed on the home page of this website. Popular retracement numbers are 38.2% down, -50.0%, and -61.8%. The beginning point of each Fibonacci cycle occurs when a stock breaks out of a horizontal consolidation pattern with a downtrend or an uptrend. I will be using an uptrend as an example. The stock will make a series of higher highs and higher lows off the base, and this uptrend could last anywhere from a few weeks to several months. Some people track trends in terms of years such as the gold market as exemplified by GLD. For trading purposes however, it is best to make money on the short term patterns.
An uptrend ends when the stock makes double or triple tops or it rounds out like the top of a mountain. A trend line could be drawn by connecting the bottom prices of the trend as the stock travels upward. When that trendline is broken as well as the backside of the mountain showing a downturn, that is the time to sell a stock and wait for Fibonacci retracement points before buying the stock again.
How do you figure those Fibonacci points? Let's take an example of a stock that broke upward out of a $50 base. The uptrend lasted until it was selling for $75 per share. The 75 will serve as the retracement base line, and the 50 will be the 100% line of the cycle. The 25 point difference will be divided up into Fibonacci sections. 38.2% of 25 is $9.55 down from $75, and that is the first important Fibonacci possible buyback point. The next point would be 50% down or -$12.50 on the share price. A third buyback price would be the -61.8% point or -$15.45, and if the stock drops below that, it might not be worth buying back. If no buyers appear at the Fibonacci retracement positions, the stock is a weak one, or we may be entering an all-out bear market.