High-Tech Fibonacci

From Investing-News.Com

Tools
High-Tech Fibonacci
By Matt Blackman, Investopedia
Dec 3, 2004, 20:51

Believed by some experts to be the greatest European mathematician of the Middle Ages, Leonardo of Pisa or Leonardo Pisano (who later became known as Leonardo Fibonacci) developed a series of numbers that has an uncanny ability to describe a variety of natural relationships/proportions--from the petal arrangement on flowers to the shape of the spiral in a Nautilus shell. In the twentieth century, Fibonacci numbers have proven themselves as tools for identifying support and resistance levels in markets. The challenge lies in learning how to apply them quickly and easily in multiple time frames and using them to trade.

Fibonacci Frustrations
The most common charting programs include Fib retracements, arcs, fans, and time-frame tools. But by the time the trader has applied these tools to multiple pivot points in multiple time frames, the chart is barely comprehensible, let alone useful for making trading decisions. As a result, most traders use these tools in only a single time frame with only one or two pivot points. While the resulting chart is easy to read, the lines are often not very significant and therefore not reliable because too much data is being ignored.

The reason for this dilemma in using Fibonacci tools is simple. Studies and long-term observations have shown that Fibonacci retracement levels--calculated using numerous pivot point swings in multiple time frames--work best in the zones in which they converge. The more often these lines converge at or near a single price level, the more significant and therefore reliable they become in determining potential pause or reversal points. But calculating and plotting these confluence levels by hand, especially intraday, is both time consuming and complex, so few are able to do it accurately or quickly enough for trading purposes.

Software Solutions
Thanks to the power of modern computers and a software tool called T-3 Fibs Protrader, plotting these levels by hand is no longer necessary. The program, developed by John and Melinda Novak of Nexgen Software Systems, takes all the guesswork and effort out of the process. Developed and designed to work with stock charting program TradeStation, T-3 automatically plots Fibonacci levels for up to 40 different time frames using multiple key pivot points and creates important confluence levels in different colors. Here are some examples of what it looks like on the computer.

Figure 1 – Display showing the S&P500 eminis plotting in 233 tick and 610 tick as well as 1, 5, and 15-minute time frames. The blue lines are automatically generated lines of Fibonacci support, the red Fib resistance levels. Chart provided by Nexgen Software Systems and Tradestation.

For the purposes of short-term trading, the Novaks have identified time frames that work best for determining usable confluence levels. An indicator called T-3 Autofibs automatically calculates key areas on each time frame. Traders can then see on the charts at which price levels these areas agree. The more times a price level generates a line in each time frame, the more significant it becomes. Using another indicator called the T-3 Accumulator, traders can then choose which time frames they find to be most useful for trading purposes and have them plot on their main trading screen (see figure 2) in various colors to determine key areas of support/resistance.

Figure 2 – The user then chooses preferred time frames in either tick or minute format to use to trade and sets up a chart to plot each in a different color corresponding to the various preferred time frames. White horizontal lines above are derived from the 233 and 610-tick charts, yellow from the one- and five-minute charts and magenta from the 15-minute chart. Where lines of different colors appear in close proximity, areas of confluence exist. The white horizontal line with up and down indentations in the lowest window is the cycle indicator and the vertical red and blue bars further help in determining trend strength. Charts provided by Nexgen Software Systems and TradeStation.

Once key levels have been chosen, the next task is to decide which levels will provide temporary support or resistance as the equity moves in a prolonged trend and which levels will prove to be reversal points. This is where skill and experience come in. Pivot points (white vertical bars in figure 2) along with the red and blue bars in the main chart window--red signifying downtrend and blue signifying uptrend--are designed to make the task of trend determination easier. But it is the rules that the trader has written in his or her trading plan that determine when and where trades will be taken.

Conclusion - Transition from Novice to Master
Becoming a successful trader takes a complex combination of skill, discipline, experience, and the ability to think in probabilities. But, while these traits are essential, the task is nearly impossible without the proper tools. In the markets, where competition is a key force, those with the best skills, experience, and access to the latest data and tools will ultimately prevail.

Many traders who have tried using Fibonacci levels to trade manually have given up on them for the reasons discussed above. But these levels do work. Programs like T-3 Fibs Protrader have proven that Fibs do provide valuable insights on key trading areas for those with the knowledge and proper tools to apply them. If you have been frustrated with using Fibonacci levels, be sure to check out T-3 Fibs Protrader--or other programs that use computer power to automate or at least streamline the process--before abandoning Fibs altogether.