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Stocks & Commodities V. 1:4 (70-73): Fibonnacci Cycles by TUCKER J. EMMETT

Fibonnacci Cycles by TUCKER J. EMMETT

The growth in popularity of my own technical application of the Fibonnacci mathematical series to the

futures markets the past ten years has been fairly remarkable, considering the amount of homework and trading discipline requisite in the approach. But the predictive accuracy and logic behind this technical system, along with the method of checks and balances obtained from it, make the effort well worthwhile.

The Fibonnacci series is the basis of the "Elliot Wave" and various forms of Elliot theory. While Elliot theory is espoused by many analysts, it is understood by very few. My own application of the Fibonnacci series evolves from a strict subdivision of the futures market into three distinct categories: Pattern, Time, and Ratio. I then require that each of these three categories have satisfied the essential framework of the Fibonnacci series before establishing a position. If only two out of the three categories fulfill their requirement, a position can be established, but the reliability factor is smaller and consequently one should commit funds less aggressively.

The Fibonnacci Series, discovered by the Italian mathematician Leonardo de Pisa in the 14th centruy, is as follows: 1,2,3,5,8,13,21,34,55,89,144,233,etc. . ., where each successive number in the series is the sum of the previous two numbers. The ratio between successive numbers can be seen to approach .618, the so called "Golden Mean" or "Golden Ratio" of ancient Greek architecture. The three important ratios the series provides us with are .618, 1, and 1.618.

With this series in mind, a trader must analyze the pattern of bull waves or bear waves in a given market, the time frame within which these waves are taking place, and the price ratio between the length of successive waves. When each of these categories has satisfied its Fibonnacci "fit", one should have obtained an entry point in the futures market which provides a fine degree of reliability, an accurate projection of profit, and a pre-ascertained risk level should one of my categories be penetrated or invalidated. Since the determination of price ratio and time cycle can be made with greater ease than pattern delineation (it takes long experience to pinpoint patterns with a relaxed objectivity) neophytes will generally use pattern as a backup to price and ratio, but in fact each element should be given equal weight.

Some examples of recent markets which are quite easy for the beginner to conceptualize;

HOGS:

The hog market made its cycle and price lows in April of 1980, and began its bull move. Major leg I gave us the requisite 3 intermediate moves in every bull phase, then corrected exactly the required 61.8% ratio of the first major wave up (December, 1982, at 38.00), and did so precisely on the 89 week cycle from the lows made in March of 1980. Consequently all three requirements were met for establishing major long positions. The second major wave up projected to a minimum of 68.00 based upon a ratio equal at least to major wave I, and this projection was achieved as my next major Fibonnacci cycle—the 34 week cycle—was completed. The Three required intermediate waves are also easily discernible in major wave 11, so that with pattern, time, and ratio satisfied at the top of the market, shorts could be legitimately entered with close stops above ratio highs, long before the trends had begun to break down or computer

Article Text 1Copyright (c) Technical Analysis Inc.


trend followers had received their sell signals.

We are currently in the process of completing our down wave pattern, with the third major down wave expected to reach the 61.8% level correction of major wave II at 49.20, with the 34 week cycle occurring the week of April 4. Shorts will be reversed and longs entered, assuming our three categories make their "fit" as expected, looking now for the beginning of major wave III back up again. Close stops below the 34 week lows will be used, so that if our time cycle is invalidated or our price ratio is severely penetrated, our risk will only be a slight one.

For the beginner, the hog market the past several years has been extremely easy to analyze and to trade on my cycles. Note also that the down wave we have been in since our 68¢ highs can be broken down very adequately into its proper subdivisions: leg 2 being equal to 1.618% of leg 1, and the correction from 52.50 to 60.00 being a precise 61.8% of leg 2.

BONDS

The bond market has provided somewhat more complexity, but has also been relatively easy to analyze and trade based on my Fibonnacci increments.

The price lows occured just a shade before the actual lows, but making long entries on the week of my 89 week cycle produced entry prices at very satisfactory levels, with the ability to use close stops below the 89 week lows. Our second leg up occured immediately giving us a full 1.618% of the first leg, and the next cycle low at 13 weeks gave us our reentry point. Very close stops would have been elected several weeks later as the 13 week cycle was briefly penetrated, but accurate pattern analysis showed the necessity of our third leg up, so there was no cause for panic, since clearly only two legs had thus far been completed. Leg 2 provided me with a 1.618 objective at (a), and our next 34 week cycle gave us new long entry points for those who missed the thirteen week entry. Our third major leg up evolved into a more optimistically bullish pattern than previously hoped for by objectives at (a), with minor legs 1 and 2 giving me objectives at the 79.00 level. Once the 55 week (34 week and 21 week) cycle had completed, our requisite pattern, time, and ratio all had been fulfilled, and shorts could be initiated with close stops above the 79.15 highs. The next major cycle occurs the week of April 11, which should provide a secondary pullback near those highs and a chance for selling the market again for the possibility of another down move, with very close stops and hence minimum risk. I see only a two wave down pattern thus far, and would expect a third minor wave before our corrective leg can be deemed safely completed.



SOYBEANS

The soybeans provide even more complexity over the past year, because of the interesting down wave pattern that evolved, the consequences of which were not clearly delineated until the lows had been completed.

Major wave II was almost equivalent to major wave I, which jibed nicely with expectations despite the tricky perambulations of the internal minor waves (it takes a thoroughgoing expert to decipher a complex Fibonnacci wave pattern), but major wave III was 61.8% of major wave II, which is a most unusual formation. Pleasantly enough the lows occurred on the bottoming out of very long term 5 year-8 year Fibonnacci cycles, so that when the move up from 5.18 occurred, one could be fairly confident that downwave pattern time and ratio had been completed and we had nowhere to go but back up, probably dramatically so.

The subsequent move up we have seen the past several months has been almost fairly easy to trade. The obvious three minor waves took place to mark the completion of our first leg up, we then corrected exactly 61.8% of this first leg precisely on the 21 week cycle lows as indicated. This provided the perfect buy in point for those wishing to capture expected leg 2 upwards in this market, having waited for secondary confirmation that we were indeed entering into a new bull phase. Leg 1 provides us with near



term objectives near $7.00 on the spot contract for leg 2, and then longer term objectives should be substantially above that for leg 3. {We are only looking at very near term cycles in the beans. Older traders will recall that beans made a move to $13.00 ten years ago, and this represented at the time the completion of our major wave II, so that major wave III is still to come, taking out the old 13 dollar highs. The minor bull moves we are looking at right now should be just the tip of the long term bull iceberg, but it does not pay to gaze too far down the track, since one risks being stopped out and losing one's position on the fast sharp cycle corrections.

GOLD

The gold market is currently the most complex of the various markets I trade and analyze. The bear market that began at 8 75 completed its three major down waves, leg 2 exactly equal to leg 1, and leg three being 1.618% of leg 2. Perfect. When our 295 objectives were hit, we had nowhere to go but back up on my work and analysis. But our 233 week time cycle hit as indicated, and our next major 55 week cycle was briefly taken out by the price lows. The predicted and expected bull move up thus occurred slightly out of cycle "sync" with wave 3 failing to meet near—term targets, but topping out very nicely on



the 34 week cycle from price lows—an unusual occurrence. We have now corrected very nearly 61.8% of our first major leg up, and when pattern and cycles also correlate, we will be ready for new long entries with next upside targets at $649.

In sum, the more intricate a market pattern becomes, the more work is required by the trader to make accurate determinations of his entry and exit points, on either a short term or long term basis. Since pattern provides a check on time and time provides a check on ratio, my technical approach provides a series of protective mechanisms which enable the placing of stops at low risk levels. When something goes wrong with a trade, one realizes it immediately and should exit immediately if any category expectation is violated. Since diversification among markets provides a further element of spreading out risk, I generally prefer handling client accounts of $20,000 or more; this permits them entry levels in the six or seven markets (out of the 20 I continually analyze) whose Fibonnacci fit is currently the most accurate, while the remaining markets can be left to percolate until they have reached a conjunction of their three requisite categories.

Figures 6Copyright (c) Technical Analysis Inc.

catalogue v 43

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