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The Indian stock market, for instance, the Nifty 50 was tumbling from its 2015 peak of 9,119.2 on the back of global slowdown and fear of interest rate hike from the US.
The index plummeted 25 per cent to record a low of 6,825.8 in February 2016 and then reversed sharply higher to revisit 9,000 in September this year.
Would anyone have thought that the fall from the 2015 peak would halt at 6,825 or had at least identified that the reversal from the February 2016 low of 6,825 is the beginning of a fresh uptrend?
Yes, for a chartist or a technical analyst, this 6,825 is a magical number that would have given him a hint of this reversal. This magical number is nothing but the 50 per cent Fibonacci retracement level of the prior upmove.
Fibonacci retracements are one of the strongest tools used in technical analysis of the financial markets. These retracement levels are used as major supports or resistance levels and to identify the reversal of a major up or downtrend as seen in the above example of Nifty 50.
So let us look at the important retracement levels widely used in technical analysis and how are they calculated.
Three levels, the 38.2 per cent, 50 per cent and 61.8 per cent are the important retracements; we can take the same example of Nifty 50 to illustrate.
The Nifty 50 was in a strong uptrend from the December 2011 low of 4,531 (L) and had moved 4,588 (P) points to make a high of 9,119 (H) in 2016.
These three numbers — the low (L), high (H) and the length of the move (P) — form the basis of the calculation. So if a strong uptrend is to reverse from a peak, the 38.2, 50 and 61.8 per cent Fibonacci retracements are considered as key supports or may be significant reversal points. They are calculated as follows
From the chartists’ point of view, the three levels, 7,366 (38.2 per cent), 6,825 (50 per cent) and 6,284 (61.8 per cent) are key support points for the Nifty 50.
Since the index had reversed sharply after making a low of 6,825 (the 50 per cent retracement level) in the last week of February and extended the bounce back move all through March, a chartist would have had a hint that the downtrend had ended, no matter what the fundamental factors would have been at that point of time.
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