How to Use Fibonacci for Trade Options
Fibonacci numbers were developed by Leonardo Pisano, an Italian mathematician in the twelfth century. Known by his nickname Fibonacci, he found that a pattern to numbers that were the sum of two previous numbers equal the third. An example is the series 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144. From this he developed the "Golden Mean" or the ratio of 1.618 which is the division of two adjacent numbers in the series. The inverse ratio is .618. This article explains how to use these numbers to trade the support and resistance levels of options.
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Instructions
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Plot the Recent Highs and Lows of the Option You Wish to Trade
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Choose a time frame that you wish to trade. If you wish to trade a 3 day horizon use a three day history. Suppose a stock option had a high of 15 in the last three day period and a low of 10. The stock option is currently at 14.
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Find the most recent high price option values that represent the following percentages of price: 38.2 ,50, and 61.8. These are the price points of support.
Using the high value of 15 we look for the Fibonacci support. Multiply 15 by the .618 Fibonacci ratio number. The result is 9.27. This is the expected major support level in a decline. It does not mean the stock should be bought there; it means don't consider buying a falling stock until it reaches 9.27. If the stock falls further, the next support level is .328 times 15 or 4.92. Traders also like to use the 50 percent retracement level as well. This would be 7.5.
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Using our low value of 10 we are looking to see potential resistance levels for our stock option. We employ multiples of the 1.618 value and find that the stock would be expected to rise until finding resistance at 16.81 and 26.81.
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Use the current price to see where price rests between the support and resistance levels you have just created. In this case our current support is found at 9.27 and our expectation of resistance is 16.81. It is important to remember that support is created from the recent high and resistance from the recent low.
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At the current price of 14 the stock option has 4.73 points of downside to 9.27 and 2.81 points of upside before being possible resistance. The trader should wait until either support or resistance is reached and then take a position. At current levels the theory would be to hold a neutral position.
As price reaches the various calculated support and resistance levels look for volume and price confirmation of these levels. If there is no confirmation, expect the stock to continue its current trend. Follow Fibonacci rungs of support and resistance. Remember to recalculate the Fibonacci series as new highs or lows are made. Adjust the time frame you are measuring.
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Tips & Warnings
Decide how short or how long a trend you want to follow before you compute Fibonacci support levels.
Fibonacci levels are ranges of support and resistance. Do not expect a quick move to the next price point if the current level is breached.
Resources
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