Shares digital

Evidence shows that, over time, price trends do not move in straight lines, they are composed of waves that build to form the trend. These waves have been the subject of different general theories of market behaviour from Dow to Elliott, among others.

Typically waves are made up of a move in the direction of the dominant trend that is larger than the subsequent contra-trend correction. However, it has been found that these contra-trend corrections often relate to their preceding trend move by a percentage amount that closely follows a relatively few known values.

Of the most significant is the 50% level, on which many market-watchers focus as a likely level of support to a correction in a major trend.

However, if you have been reading this column, you will have seen the Fibonacci retracement levels of 38.2% and 61.8% referenced (a minor additional level is at 23.6%). Fibonacci levels are derived from the series of the same name, which can be observed in many progressions in nature from the spirals of a snail’s shell to the breeding rates of rabbits. Together, these three percentage levels can be used to define possible termination levels for a correction. If these levels coincide with retracement levels from larger trends then we get the effect of ‘nesting’ of levels, and this adds to their significance. If other technical features also fall close to the retracement levels then we can have further faith in their significance. This concept of retracement of a trend or move works for upside corrections in bear trends as much as it does for downward corrections in bull trends. Importantly, if the 61.8% retracement level fails to arrest a correction, then the expectation is that a full correction of the previous move will be seen. (Note: though the chart of BP is using a log scale Sharescope can apply the correct percentage lines).