Technical Analysis – Fibonacci Retracements

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Figuring out if this is a ‘modest’ or ‘deep’ pullback is the key to determining your next move.

This is the perfect situation for technical analysis.  The tool I use to measure a pullback is Fibonacci Retracements.  This tool measures the size of the pullback against the rally.  The levels of retracement identified by Fibonacci are 38.2%, 50%, and 61.8%.

Why these levels?  That’s a little much to get into here.  Trust me, knowing these three levels is the key.

A pullback of 38.2% to 50% before moving higher is a normal part of rallies and should be viewed as a good time to buy or add to your positions.  However, a retracement of 61.8% or greater could mean this rally is about to come to a screeching halt.

Let’s take a look at the recent action of the S&P 500.

As you can see from this chart, the S&P 500 hit a low of 666 on March 6th and a high of 803 on March 19th.  This puts our Fibonacci Retracements at 751 (38.2%), 735 (50%), and 718 (61.8%).



A retracement to 751 or less before moving higher is very bullish.  This is a sign to buy.  Add to your positions quickly.  We should be in store for a good rally.

A pullback to 735 is a little less bullish but the rally should continue on up.  Hold onto your positions and look for more information before you pull the trigger.

Falling all the way down to 718 isn’t good.  It means any rebound will probably be short lived.  Beware of this market running out of steam.

But what do you do if it breaks below 718?

If this level is broken, we’re going lower.  Most likely all the way back down to the recent lows.  It could fall from 718 all the way down to 666. A move of more than 7%.

This could be a perfect situation to hedge against a downward move instead of selling all of your long positions.  It’s not hard to hedge the markets these days.  You can hedge your long positions by shorting the entire S&P 500.

An easy way to short the entire S&P 500 is by using an ETF.  And since the rally took place over a short period, the fall should come just a fast. This makes a leveraged ETF a better way to not only hedge but to capture a gain on this short term move.

The ETF I like for a trade like this is the ProShares UltraShort S&P500 ETF (SDS).  You could turn a 7% sell off into a quick 14% profit!

You can use Fibonacci Retracements to listen to what the market is saying.  A modest pullback to 735 could mean we’re about to burst through to new highs.  A deeper pullback to 718 indicates the rally may be running out of steam.  And a retracement beyond 718 tells you it’s time for a short term hedge.

Listen to the market, it will often tell you where it’s going.

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