Sunday, June 22, 2008

Fibonacci Time Zones on Nifty

I’ve written a number of posts about the Fibonacci Series and the importance of Fibonacci numbers in the stock markets including a webinar on the Fibonacci sequence. A few of such posts have been listed near the end of this post.

The Fibonacci Series was given by an Italian Mathematician by the name of Leonardo of Pisa (1170-1250AD), who was also known as Leonardo Pisano, Leonardo Bonacci, Leonardo Fibonacci or simply Fibonacci. A very interesting story is attached to why he was called Fibonacci. Leonardo’s father Guglielmo was nicknamed Bonaccio (meaning ‘good-natured’ or ‘simple’) by his friends and Leonardo was called filius bonacci (which means son of Bonaccio) which was later nicknamed Fibonacci.

The Fibonacci Series is a series of numbers which starts from 0 and 1 and each of the succeeding numbers in the series is derived by adding the previous two numbers in the series. So it goes as 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377 and so on. Each number is 1.618 times its previous number, 2.618 times the number before that and 4.236 times the number before that. Similarly, each number is 0.618 times its next number, 0.382 times the number after that and 0.236 times the number after that.

Fibonacci is present everywhere in nature and
this video very well describes it. Needless to say, even the stock markets rely heavily on it. Elliott Wave Principle says that markets move in a direction in a series of 8 waves out of which 5 waves are in the direction of the trend and 3 move counter to the trend. Interestingly, all three numbers 3, 5 and 8 are Fibonacci numbers. It is a known principle that when markets retrace a particular move, they generally find support/resistance at Fibonacci ratios which is why the ratios 23.6%, 38.2%, 61.8%, 161.8%, 261.8% and 423.6% hold a lot of importance. A lot of material can be found on various Fibonacci techniques used in the stock markets such as the Fibonacci retracements, Fibonacci Arcs, Fibonacci Fan Lines etc. However, I am concentrating today’s discussion on the Fibonacci Time Zones. According to the Investopedia, the Fibonacci numbers play an important role in determining relative areas where the prices of financial assets experience large price moves or change direction. There are various examples which show that markets show a high range candle or change direction on the 3rd day, 5th day, 8th day, 13th day, 21st day, 34th day, 55th day and so on. Today’s discussion, however, won’t delve into high range candles but will only concentrate on change of direction.

Before I go deeper into the subject, I would very quickly like to emphasize how the Fibonacci numbers affect the markets naturally. A week consists of 5 trading days (a Fibonacci number), a month consists of 21 or 22 trading days (21, again being a Fibonacci number) and a year consists of 245-250 trading days (being very close to the 233 Fibonacci number). Interestingly, a year has 52 weeks (very close to the 55 Fibonacci number) and 8 weeks consist of 56 days (close to the 55 Fibonacci) and 8 months consist of 240 days which again is quite close to the 233 Fibonacci mark. So, Fibonacci occurs naturally. Nobody had any real intention of making the markets respond to Fibonacci numbers but they naturally do.

Nifty Weekly Chart - Fibonacci Time Zones

I have the weekly chart of the Nifty above, and on it I have drawn vertical lines where a significant market top or a market bottom was formed. Then I have calculated the distance between the top and the next or the previous bottoms and written the number of weeks taken to reach the next low/high. As can be seen from the numbers the market has been consistently making use of Fibonacci numbers like 3, 5, 8, 21 (on some occasions it has deviated to 20 or 22 also) and 34 (though, on one occasion it took 35 weeks) to turn around right from the low formed in May 2003 till Jan 2008. Another interesting thing to note is that the bull market that started in May 2003 and ended in Jan 2008 has taken a total of 55 months, 55 again being a Fibonacci number. Interestingly, the turnaround that happened in Jan 2008 and which has been continuing till now has now completed 24 weeks and is now in the 6th month which has decisively crossed the 21 number mark and the Fibonacci number 5. It means that the markets may not turn around till 34 weeks or 8 months are completed or if things do turn out to be very bad then maybe 55 weeks or 13 months. But we should be looking at the last week of August very carefully as a possible turnaround time because that is when the markets would have completed 34 weeks of a downtrend.

But what about the downside? How low can go the markets go? Let us make use of the Fibonacci retracements this time. The Nifty made significant lows of 599.51 in March 1993, 800 in Nov 1998 and 920 in April 2003 and a significant high of 6357.10 in January 2008 (I can’t help noticing that these are spaced more or less 5 years apart, 5 again being a Fibonacci number). Calculating the 38.2% retracement levels from these different lows to the same high of 6357, we get the support levels of 4280, 4234 and 4157. These are some of the levels where the markets should eventually find support.

I heard an analyst speaking on TV a few days back who was saying that after a long bull market a correction in price as well as time is required. He was saying that we may have seen two thirds or more of the price wise correction but have seen only a third of the pain. He said that in the weeks to come, the price may not fall too much but a lot of pain will be there, which is imminent if the markets were near the support and the bulls and the bears continue to fight near a particular level trying to decide what an appropriate bottom for the market is. Even after the bottom is formed, the pain will not be over since, then the market could go into a long period of consolidation and base building before a significant recovery in price is seen. If this were to be true, we may see a bottom being formed in the last week of August 2008 but a significant price increase (maybe a breakthrough above 4700 or maybe 5000) may not be seen for the rest of the year.

We have tried and have made an effort to analyse what the market may do but, ultimately, the markets have a mind of their own and can prove us wrong anytime. We have to be quick and humble enough to accept our mistakes and change our stance if the markets were to prove us wrong. On the other hand, if the market does move according to our wishes then we know the price levels and the approximate time where we can be more careful and decide whether the market has a mind of proving us right or not. As I said, technical analysis is all about
the probability of profitability.

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