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As I predicted last month, September's been a volatile, "down" month. In fact, the big indexes are on pace to turn in the worst September results since 2011.
But, like always, there are some juicy opportunities in all that volatility. Volatility's always a trader's dream, because a stock's got to move – up or down – for us to make money. The more the price moves, the better.
Right now, I'm going to show you an old – as in, 800 years old – method you can use to spot stocks that are about to move, and how to work out how far they're likely to go.
That's not only a huge factor in spotting stocks you might like to buy and hold at a good price, but it can also help you find when and where to move in your trading…
Let's get started…
This Is a Great Buy/Don't Buy Indicator
Right now, all the downward volatility means some really big stocks are going for really great prices – prices that look like they're getting better, too.
This could be ideal for trade setups, as well.
And I can spot these levels, where stocks are retracing their moves, because of something called the "Fibonacci retracement."
I'll tell you a little bit about this technical indicator and the guy that invented it – then I'll show you how to use it yourself.
Fibonacci was born in Pisa, in what's now Italy, around 1170 – right around the time they were breaking ground on the Leaning Tower. It hadn't even started to lean yet.
Fibonacci was really into numbers. As a boy, he went with his father, a trader, to what's now Algeria, where he was exposed to the Indo-Arabic (0, 1, 2, 3, 4) numeral system we use today.
No mystery why he was fired up about those numerals – bookkeeping, which is important for merchants, is really hard with the Roman "I, II, III, IV, V" numerals. Having things like the zero and place value changed everything, and the idea spread like wildfire across Europe.
Now, Fibonacci rediscovered a sequence of numbers the ancient Indians first hit on, where, when you start from zero, each next number is the sum of the two that came just before: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and on and on.
Each number is about 1.618 times greater than the number before it. And the relationship between all these numbers in the sequence is the foundation of common ratios when studying retracements (the percentage by which the market corrects itself).
That 1.618 brings us to the "Golden Ratio."
People were obsessed with the Golden Ratio in ancient times, but even today, folks have written whole books and spent their entire careers studying the Golden Ratio and the Fibonacci sequence.
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That's because it turns up in the strangest places – seashells, human faces, architecture, plants, and galaxies, just to name a few.
And, as I mentioned earlier, it shows up in the way stocks move, too.
You determine it by dividing a number in the sequence by the number that follows it. For example, 55/89= 0.617, 34/55= 0.618, 21/34= 0.617, and so forth, making 61.8% the key Fibonacci ratio.
There are also two other key ratios: (1) 23.6%, which you can find by dividing one number in the sequence by the number three places to its right, and (2) 38.2%, which you can find by dividing one number in the sequence by the number two places to its right.
Cool History Lesson – Let's Talk Stocks
Have a look at the good old SPDR S&P 500 ETF (NYSEArca: SPY). This will make more sense if we round off the prices a bit.
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We've got the low, call it $220, we hit back in March, and then the run up until about Sept. 2, when we got close to $360.
And we've already started to pull back. How far down do we have to go before we hit a Fibonacci number?
A trip down to $306 would be a 38.1% pullback, $290 would take us down 50%, and $274 would be a 61.8% pullback from the high.
The most important thing to know is the Fibonacci retracement, or "Fibo" as traders call it, can easily give you the support or the resistance level of any stock you're interested in. It's extremely handy for picking your entry points, too, whether you're putting on a trade or just looking at a stock to buy and hold.
With all the downward volatility out there, it's no coincidence right now that some big stocks are at or testing key Fibo levels right now.
The Fibo works. I use it a lot. If you want to do this yourself, it's easy – you take an extreme low and an extreme high. You plug in your Fibonacci retracement levels – 23.6%, 38.2%, 50%, and 61.8% – along the price axis, and there you've got your entry points.
The Fibos are good for a lot more than that. If you're bearish on a stock, short or trading puts on it, the Fibos can help tell you when to pull the ripcord on your trade.
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It's almost like getting paid to buy stocks.
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About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.