How to take a calculated risk in the stock market by using Fibonacci Cycle

To make the most of the opportunities that equity markets present, one needs to timely take a call on a particular stock movement. While fundamentals of a company support long-term prospects, technical analysis can help an investor eke out (and/or avoid) short-term gains (losses) by helping him/her identify reversal in a stock’s trajectory.

One of the widely used analyses to identify such swings or reversals is Fibonacci cycles or Fibonacci Time zone. Under this analysis, an investor studies major swings or reversal points of a stock, or index, over a period of time. These points, known as Fibonacci Intervals, are nothing but vertical lines that extend towards the right side of a technical chart and indicate areas of time that could result in another significant movement.

These intervals are based on Fibonacci numbers 0, 1, 1, 2, 3, 5, 8, 13, 34, 55 and so on where each successive number is the sum of the last two numbers. The vertical lines appear on the chart on the aforementioned days to indicate major areas of significant change in sentiment and/or increased investor participants. That is to say, if we start an analysis on May 1, this would be time (0). The first Fibonacci time zone vertical line will then appear on the next trading session (1), the second will appear two sessions later (2), and then three (3), five (5), and eight (8) days later, and so on. The indicator is plotted considering either high, low or a reversal point.

Key significance of Fibonacci Cycle

• Provides indication of major moves in terms of time scale.
   
• A potential indicator to attract attention of market participants at crucial moves.
   
• The significance is given to the time / vertical line and not to the price. Herein, the price is a silent tool.
   
• It can also act as an indicator to enter or exit positions.
   
• Fibonacci Retracement provides support and resistance levels, but Fibonacci cycle explains about the time significance. Both the indicators in conjunction assist in better confirmation.

The strategy deployed while using the Fibonacci cycle purely depends on the high or low or reversal points identified. One needs to be very careful while selecting the price to display the outcome as this will help to accurately gauge the underlying strength in a stock and develop strategy to optimize returns on a crucial time scale.

Fibonacci Cycle also facilitates an investor in taking a calculated risk at different times as time zones can result in significant price movement that can alter the overall sentiment. Moreover, the indicator enables him/her to identify the crucial support and resistance points as a shift in momentum can also occur around these time zones.

Furthermore, traders and investors can use these crucial lines to minimize risk on their portfolio holdings. Lastly, one needs to study the overall trading position in terms of the interest initiated by market participants as higher the interest, greater is the bullishness in the stock and vice versa.

Let’s consider the daily chart of UPL Limited. Herein, one can see the stock witnessed significant movement in the counter on each of the vertical lines (0, 1, 2, 3). Now, according to the Fibonacci Cycle, the immediate and the most important move will come at the 5th session. This may show continuation of the upward session or profit booking. Unless a clear direction does not emerge, the next significant time level would fall on the 21st session. CLICK HERE FOR THE CHART

These vertical lines also indicate the support and follow-up momentum. As can be seen, a sharp upside after the 5th vertical line saw a strong momentum and the counter witnessed a sharp rally on the upside.

Although, the current price level shows overbought condition, the price strength is not showing any major weakness. The next session to watch is the 5th session whose price level may predict the next outcome of the rally.