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Fibonacci and trading. How to trade on the exchange using Fibonacci retracement levels.
If there are ratings of the most popular instruments for analysis, Fibonacci retracement levels are in all of them. We are sure in it. Great traders speak about them in their interviews. Recently, we even discussed a Forex trading strategy based on Fibonacci numbers and Elliott waves. Today we publish an expanded article about significance of Fibonacci numbers in trading.
Read in this article:
- who Fibonacci is and where Fibonacci numbers came from;
- what CFA and EWA are;
- correction and retracement levels;
- internal correction patterns;
- extension levels;
- projection levels;
- Fibonacci zones;
- Fibonacci retracement levels and footprint;
- additional literature about CFA.
We will use the market of gold futures as an example in this article, but you can, as well, apply Fibonacci retracement levels in any other market with any timeframe.
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Who Fibonacci is and where Fibonacci numbers came from.
The mathematician Leonardo of Pisa lived in the 13th century and was one of the most famous scientist of his time. The Fibonacci name was derived from two words ‘filius Bonacci’ (son of Bonacci), written on the cover of the most famous work of Fibonacci – ‘Book of Calculation’. Sequence of numbers, which we call now Fibonacci numbers, originates from the problem about rabbits. Leonardo tried to solve the problem about how many rabbit pairs would be inside a fenced area in 12 months from the beginning of reproduction, if there is only one pair in the beginning of the process.Starting from the third month rabbits reproduce recurrently, which means that every subsequent number equals the sum of the previous two numbers: 0,1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 and so on to infinity. By the way, if you are still wondering how many rabbits would be in 12 months, the answer is 233 pairs.
We have a pair of questions after this historical excursus:
- why Fibonacci studied rabbits;
- how the results of the experiment with rabbits could be used in trading.
In fact, the mathematician Fibonacci was not interested in agriculture and didn’t plan to breed rabbits. He systemized knowledge of ancient Greeks and Indians in his ‘Book of Calculation’, introduced Arabic numbers and multiplication and analyzed various mathematical problems, including the one about rabbits. If we divide any number in the sequence by the previous number, we will get the number, which tends to 1.61803398874… This number is called ‘the golden ratio’, ‘Divine Proportion’ or one of the treasures of geometry. It attracted interest before Fibonacci. It is called by the Greek letter ‘phi’ in algebra .
|1:1 = 1.0000||which is lower than phi by 0.6180|
|2:1 = 2.0000||which is higher than phi by 0.3820|
|3:2 = 1.5000||which is lower than phi by 0.1180|
|5:3 = 1.6667||which is higher than phi by 0.0486|
|8:5 = 1.6000||which is lower than phi by 0.0180|
If any number in the sequence is divided into the subsequent one we get the number, which is reciprocal of phi 1.618 (1:1.618) or 0.618. If we divide any number in the sequence by the number, which goes after the subsequent number in the sequence, we get 0.382. Here we found Fibonacci numbers in the form, which is familiar for traders.
What CFA and EWA are
EWA is the Elliott Wave Analysis. Fibonacci retracement levels are closely connected with the Elliott Wave Theory, because Fibonacci numbers are used for assessment of the wavelength.
CFA is the Comprehensive Fibonacci Analysis. It emerged as independent of Wave Analysis for global markets with high volatility. Price corrections are mainly used in the Forex market for trading by CFA. Further on, we will consider CFA instruments: Fibonacci correction, projection and extension levels. The main idea of using CFA instruments is to find a level, from which the price would reverse. The instruments are used both individually and jointly. It is very important in CFA to build any Fibonacci retracement levels correctly, that is correctly identifying beginning and end of a level.
Correction and retracement levels.
Correction or retracement is a movement against an existing trend. Correction ‘eats’ a part of the trend movement. The following Fibonacci numbers are most often used for the correction levels:
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Correction levels are built by candle shadows, that is by their high and low points. You need to find a trend, first, in order to build a correction level. All traders build trend lines differently – there is more creative activity in it than a systematic approach. If you have doubts, the ZigZag pro indicator will help you to identify the upper and lower points of a trend line. Since Fibonacci retracement levels could be unsymmetrical, pay attention to where the wave, by which you build levels, starts and ends. In case the trend is descending, there is 0% in the bottom and 100% on top. And it is vice versa if the trend is ascending. If someone gets confused with sides or used to build correction levels always in one direction, the trading and analytical ATAS platform can arrange mirror reflection of levels in one click.
Example. Let’s build correction levels in 10-minute E-micro Gold futures (MGCM9) chart.
We used ZigZag pro with the 40 ticks setting for identifying the trend. If you do not know what indicator settings should be used, watch this video on our channel. The trend correction in our chart ends in point 1 after deviation from the high by 38.2%.
The most significant correction level is 61.8. A new trend starts, as a rule, in the opposite direction, when this level is broken, and it is necessary to build a new correction level.
Internal correction patterns.
The correction pattern is a movement between insignificant correction levels, after which the price, most often, moves to the key level of 61.8. There are 4 patterns depending on namely what correction levels are touched by the price. We will not discuss all patterns in detail. We will show one example, which is called IP2 or price movement between the 38.2 and 14.6 levels. Theoretically this pattern looks as follows:
Real-life example in an hourly E-micro Gold futures (MGCM9) chart.
We again built trend lines with the help of the ZigZag pro indicator with 100 ticks setting. The price touched the level of 38.2 in points 1 and 2 and bounced to the level of 14.6. This pattern warns us that the price, most probably, would move to the level of 61.8, which we see in point 4. The level of 61.8 is a key level. The previous trend is broken when this level is broken.
Extension is a movement towards an already existing trend.
For example, here are the numbers, which are used for extensions by Derrik S. Hobbs, the author of the ‘Fibonacci for the Active Trader’ book:
There are two types of extensions. The first type means additional levels, where the price may reverse. The second type means the zone between additional levels, inside which the price may stop and reverse.
We added extension levels of blue colour to the correction levels in the following 10-minute E-micro Gold futures (MGCM9) chart.
The price reached the extension level of 127.2 in point 1 and bounced back.
What is Fibonacci Retracement
By Market Traders Institute
Step 1: Understanding the Fibonacci Sequence
As Italians named Leonardo go, Fibonacci is, at most, the second most famous (some guy named Da Vinci takes the number one spot). However, Fibonacci can do something for you that Da Vinci never could, fibonacci can make you money. Fibonacci’s fascination with numbers led him to discover the mathematical sequence that bears his name (also known as the Golden Ratio).
The Fibonacci sequence is as follows: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377… You may have seen this sequence of numbers on a test, a puzzle or in popular fiction like The DaVinci Code. But what does this sequence actually mean?
Fibonacci’s sequence says that, in a group of three numbers, the sum of the first two numbers will always equal the next number in the sequence.
1 + 1 = 2
1 + 2 = 3
2 + 3 = 5
3 + 5 = 8
You can see how the pattern works. Take whatever number the equation totals, add it to the second number in the equation and the new total will equal the next number in the sequence.
Step 2: Finding Fibonacci’s Golden Ratio & More
Now that you know how his sequence works, you can learn how to find what traders call “the golden mean” or “golden ratio”. You arrive at the golden mean by taking any number in the sequence and dividing it by the number that immediately follows it. This answer will be .61 or 61% (or thereabouts). So if we bring up our sequence again…..
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377
13 ÷ 21 and get 0.619
21 ÷ 34 and get 0.617
34 ÷ 55 and get 0.618
You can use the sequence to get other important ratios as well. These numbers are: 0.38 (dividing any number by the one two places to its right), 0.50 (the sum of three numbers divided by two), .786 (the square root of .61), 1.618 (dividing by the number that immediately precedes your number), and 1.27 (the square root of 1.618).
Step 3: Applying the Fibonacci Numbers to Your Trading
The reason why Fibonacci’s sequence is such a big deal is because it can be found all around nature. Everything from seashells and starfish, to trees and the distance between your elbow and hand all follow the patterns first discovered by Fibonacci. And there is strong evidence that patterns in the Forex follow this sequence as well.
Based on your entry point in the market, you can place lines on your chart that correspond to the numbers laid out by the various equations listed above (.61, .38, .78 etc.). It has been shown that, over time, the market’s rises and falls generally match up with Fibonacci’s lines. In theory, if you set your buy and sell points according to these patterns, you will be able to sell before the market turns down, and buy before it goes back up.
Finding the Fibonacci numbers are difficult enough, putting them on your chart is even more difficult, and fully understanding how they work is the most difficult of all. There’s no reason why you should try and understand this yourself.
How to trade using the Fibonnaci Sequence
Very popular in the world of trading, the Fibonnaci sequence has been used ever since technological breakthroughs led towards the wide-spread use of trading technologies for the common man. You’re reading this article because of your interest into trading.
Whether you’re interested in starting, or you’ve already started trading, I hope to bring to you quality information regarding this method and its application in modern day trading. But first, I want to share with you the story of the person who is responsible for popularizing this sequence to the western world. I say popularized, because it is a little known fact that he was not the first one to discover it, but read on and I will share this information with you.
Who was Fibonnaci?
Nicknamed Fibonacci, an Italian mathematician whose real name is Leonardo Bonacci lived in Pisa, and he was born into a humble family of traders in 1170. His father was named Guglielmo and he worked at a trading station in Bugia (currently Béjaïa), which is a Mediterranean port in northern Algeria. Leonardo studied mathematics in Bugia, but he was also an avid traveler.
Through his travels he discovered the Hindu-Arabic numerical system and quickly figured out its advantages over the current systems in place. He is one of the most influential people that led to the adoption of the Hindu-Arabic numerical system by the western world. The way he became so influential was through his book called “Liber Abaci” or rather, The Book of Calculation, which he published in the year 1202.
In his book “Liber Abaci”, he introduces the “modus Indorum”, meaning “the method of the Indians”, which we recognize today as the Hindu-Arabic numeric system. This book explained the use of the numbers 0 to 9 and introduced the concept of placement value. It presented detailed examples of how to practically use this, to the western world innovative method. The examples included the application of Arabic numerals to bookkeeping, weight and measure conversion, interest calculations among other things. Educated Europe absolutely loved the book and it was so well-received that we can feel the effects of it’s influence even today. In the following years from 1202 to 1228 this system completely overtook the previously used Roman numerical system and improved the overall business calculation capabilities, which eventually leads to an exponential growth of accounting and banking in the heart of Europe.
Within the book, there was an interesting proposal, an observation of a problem. It involved the growth of rabbits in ideal conditions. Within the solution to this mathematical problem, was contained a sequence of numbers, which we now know as Fibonacci numbers. Interestingly enough, this is not the first time this sequence was recorded, since historians have discovered documents by Indian mathematicians at least 600 years before Leonardo himself discovered it.
Even though Fibonacci discovered this sequence, he didn’t extrapolate the relationship between the numbers and their ratio. His method was to simply collect the starting number one, add it up with every number before it, and so on.
For visual purposes the sequence is as follows:
1+1=2, 2+1=3, 2+3=5 and so forth in order to get this particular sequence….
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377…
What he didn’t realize is that the ratio between the numbers, keeps a strong tendency towards a certain number which we know as the Golden Ratio, and it was discovered by Phidas between the years 500 BC – 432 BC.
The golden ratio can be found in nature, as well as human creations like trading systems.
Introduction to Fibonnaci ratios
Let’s first take a look at the numbers in the Fibonacci sequence again:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377…
What is being called the Golden Ratio is actually the relationship between each and every consecutive pair of numbers in the sequence. If you want, you can spend some time to divide each number with the previous one and see it for yourself, but I will do the calculation below for you anyways. What we are going to notice is that with every division the result keeps getting closer and closer to one specific number, which is easily rounded to 1.618.
Now this information is still useless when considering trading, but it’s important to know it for later in the article, because we will learn how to utilize the ratios gained by the following divisions into a concise and specific trading strategy.
If we continue these calculations we will reach the phi number, known today as the golden ratio, which is 1.61803398875, but for ease of communication we will round it off at 1.618. We can utilize these ratios when analyzing charts in different ways, but primarily they are used to predict the outcome of trends, either upward or downward trends.
This article can serve as both an introduction and directory towards other Fibonacci trading tool related articles. It has been suggested that humans are attracted to this pattern subconsciously, but we will leave the metaphysics for the philosophers. Truth be told, you should always try to make the most informed decisions when trading. I’m saying this because in reality the Fibonacci Ratios are not in any direct correlation with trading systems, commodities, currencies and they do not affect the market price of goods in any way. What you should consider though is that there are thousands of other trades who are using this tool to speculate the future state of the market. I’ve personally enjoyed some success when trading using this tool, but it’s never recommended to go all-in on the markets. Spread your funds, keep a professional attitude and you will turn a profit regardless of anything.
Anyways, let’s not waste any more time and let’s dive right into the specific technical details!
Fibonacci Trading Tools
From the previously derived ratios we can generate five different types of trading tools that are very useful when analyzing charts in the various marketplaces, regardless of whether we are talking about stocks, bonds, securities or cryptocurrency. The available Fibonacci tools can be used in any market, at anytime, but some tools are better for long-term analysis, while others are very effective at predicting short-term outcomes:
The available Fibonacci trading tools are:
- Fibonacci Arcs
- Fibonacci Fan Lines
- Fibonacci Extensions
- Fibonacci Time Zones
- Fibonacci Retracements
Using these tools within your trading software or exchange platform is going to create lines which after reading this article you will be able to use to extrapolate valuable information, that will help you make the right trading decisions.
Let’s look at some information explaining how these ratios allow efficient chart analysis.
How do the Fibonacci trading tools work?
It is a very popular idea that when correctly applied the Fibonacci trading tools will present about 70% correct market prediction in individual cases, while other traders say it’s both a time and effort-intensive investment, which provides unrealistic and unreliable information.
The truth is that nobody really knows why the Golden Ratio appears in trading charts, in the size of our hands, in the way we build our cities and make our art. It’s literally everywhere and all evidence suggests that people are using it subconsciously for the most part.
Most of the traders find Fibonacci results to be way too complicated to read and use confidently, but there are those who swear by it. It takes a while to get used to reading the results and making the correct chart measurements. In general you shouldn’t get attached to the results that any trading tools will produce and you should base your predictions on more relevant price movers, such as governments passing new laws, new companies in the specific market, or similar news that bring about real change instead of the psychological notions of traders on the market.
You should consider the Fibonacci Tools as a way to look at charts in a different way and understand that they influence the decisions of other traders on the market. This argument is reasonable, because of the fact that all of the tools are available to everybody and most serious traders for whom trading is a business will use them on a constant basis. Therefore its safe to assume that Fibonacci results present the notions of traders and what they consider the price of a commodity to be, regardless of real events.
The Fibonacci Trading Tools have been created as a way to dispel trading uncertainty, so they really, really shouldn’t be the basis for your trading decisions. But rather you should be focusing on the events that have real market driving power and shape the prices of goods.
The Fibonacci studies become a very active factor when used by a large number of traders, although it’s very unfortunate that we don’t have a way of knowing how many traders are using the tool at any particular way of knowing how many traders are basing their decisions off of these tools. Most of the time they work by driving traders to artificially create their predicted support and resistance levels.
Basically the Fibonacci studies work, because of the belief that they work. A lot of traders have experienced the so-called self-fulfilling prophecy and they’ve experienced the results that the tool has predicted. In reality there is nothing to base the decisions upon, except that the ratio is found in many surprising places in nature.
Always remember that the market is a very complex system and it’s being influenced from a variety of different factors, one of which is a large number of people looking at a charting tool and believing in its predicted outcome. I know I must be boring with this, but do not take comfort in the results you get with this tool. The markets are inconsistent, difficult to predict and it’s easy to make a mistake that can cost you a lot of money if you’re not care full.
As a conclusion to this point, you should use the following tools in combination with other charting tools and the results should be taken as a vote for or against a certain decisions, while also taking into account the results gathered from the other tools for technical chart analysis. This way you will evade the trap of over-reliance on the Fibonacci Method and make well informed and confident decisions.
Let us now delve into each and every tool and describe the main features it possesses, together with what we can hope to achieve with each tool individually.
Fibonacci Fan Lines
This particular charting technique uses three diagonally placed lines that use the Fibonacci ratios in order to help you identify future key levels of support and resistance on the markets.
They are created by drawing a trendline from the highest to the lowest price in any given period of time. Based on this initial trendline, the tool generates the other lines, by making a division between the vertical distance of the two selected points by the most important Fibonacci ratios, which are 38.2%, 50% and 61.8%. The fan lines are then created based on the results of the multiple computations, where every line passes through each of the three different results.
Just like the Fan Lines charting technique, the Fibonacci Arcs are used for identifying nominal support and resistance levels and their ranges, by drawing three curved lines based upon the Fibonacci ratios.
They are created by drawing a trendline between the highest and the lowest price point in a given period and then drawing three intersecting arcs going through different ratio points based on the key ratios, 38.2%, 50% and 61.8%. This helps you make trading decisions when the price of your chosen commodity passes through one of these levels. The price of the asset will usually move between 38.2% and 61.8% allowing you profitable long and short positions on the particular market that you’re involved in.
Fibonacci Time Zones
Considered to be an indicator, usually used by technical traders to identify period in which the price of the selected asset will experience high amounts of increasing price action and upward trends.
This particular charting technique utilizes the sequence known as Fibonacci Numbers, which we mentioned before. Based upon these numbers the tool generates vertical lines that begin at the chosen starting position. It is usually used for long-term planning and it’s highly suggested that the chosen starting point is a moment in time when a large market movement has already happened. From this starting point onwards, the tool generates the vertical lines on a per-day basis corresponding to the particular value of each subsequent number in the Fibonacci number sequence.
This tool is used within Fibonacci Retracement, which we will save for the end of the article. It provides valuable information regarding the places of support and resistance on the markets. Extensions are composed of all the different levels, based on important Fibonacci ratios and are often used to determine which areas will provide the traders with profit, so that these traders can expect and place orders ahead of time.
What do we mean by retracement? The term explains a situation where the price of an asset moves in either upward or downward motion and then bounces back slightly, often to the 38.2% level, but frequently enough to the 61.8% level as well. It is recommended that you use this tool when the market moves more than a 100% of the previous movement. When used in combination with other indicators and patterns it allows traders to place realistic price targets for their assets.
It is not uncommon for the market to follow these extensions and many traders take the information gathered by using this tool as reliable, although the real reasons for the markets to follow the results of this study are completely unknown and irrational.
The best practical way to use Fibonacci extensions is when the prices of assets are at new highs or lows and there is absolutely no clear date as to what the support or resistance levels are on the charts. When in this particular situations, you can use this tool to get a basic idea of approximately where the asset is going to start falling in price, so you can get out of the market at the right time. Using these tools increases your chances at making profits regardless of the fact if you’re trading long or short. Fibonacci extensions can be used to calculate both upward and downward movements on the market.
With this being said, the only way to be really practical is to make decisions based on other factors as well, not only on the Fibonacci extensions. Wise traders will wait for candlestick patters, like price action, to become convinced that a stock is going to reverse at the target.
These extensions are easily applied to any trading style, regardless of whether you’re trading on a montly or a five minute chart, these tools can help you set relatively realistic price targets and also expect the future movements of the market. However consistent the results of these tools are, it is very important for you to know that you should absolutely never allow Fibonacci to be the one and only deciding factor in your trading decisions, because as I have said more than a couple of times in this article, the results gathered from these tools are simply projections based on the specific ratios which for some reason correlate with the movements of the market. They are no specific reasons for these changes in price, except for people’s willingness to sell and buy at any time.
This term is used in technical analysis and it refers to areas on charts signifying support and resistance. Fibonacci retracement uses horisontal lines to highlight areas of expected support and resistance at key Fibonacci ratios, before the particular trend continues in the original direction it was headed towards. To create these levels, you need to draw a trendline between the highest and lowest price of a period and the tool then divides the vertical distance by the most important of Fibonacci’s ratios, 23.6%, 38.2%, 50%, 61.8%.
It is a very popular tool used by technical traders, because it helps them identify places where they can strategically place transacions, price targets and stop losses. The notion of Fibonacci retracement is used in many different indicators, including but not limited to… Gartley patterns, Elliot Wave Theory and Tirone levels. For some unknown reason, after the market moves significantly the new support and resistance levels are usually near the results of the Fibonacci ratios. These levels are static and they do not move together with the chart like moving averages do. Their static nature allows for an easy and quick identification of price levels and subsequent order creation. This allows both long and short-term traders to expect and hastily react to the market when these price levels are starting to get tested. The ratio levels signify places where it’s usual for the market to struggle and either break to a new height or fall back again.
Trading Fibonacci Retracement Levels
These retracement levels can be used as triggers for buy orders or drawbacks in an uptrend. It’s highly encouraged that you utilize other tools and indicators such as the 200-day moving average, because when they overlap with the results for the Fibonacci retracements it generally suggests a fortified support or resistance is to be expected.
The one to keep an eye at is the 0.618 or rather 61.8%. This is the usual bounceback that the market makes when due to fear, most of the asset holders will release, but there is always someone there to pick up a bargain and it often drives the price up to the 61.8% level, where it usually peaks out before plummeting back into a down trend. Some of the more conservative traders hold out for a few waves before setting trades in order to ensure themselves that the support and resistance factors are there.
Did you like this article? I really hope that you’ve picked up on some new and useful information that you can utilize in your technical analysis of market charts.
What is Fibonacci Trading? Easy to Learn and Use
Aside from having fun, traders are always on a quest to capitalize on financial market inefficiencies. It’s this never-ending hunt for profits that lead them to innovation.
Of the many trading strategies and indicators, traders incorporating Fibonacci tools into their charts will have an edge. There are several reasons why market participants place this tool on a pedestal.
What is Fibonacci Trading?
Understandably, the incorporation of Fibonacci ratios in trading charts can be due to the ever-evolving market conditions or the improvement of existing strategies with the overarching objective of better understanding the trading landscape.
Taking into account that a timely entry or exit can make a marked difference between profit and loss, this decades-old technique finds widespread use in asset trading. And it doesn’t matter which security or asset you’re using. Fibonacci-derived tools are cross-cutting, practical, and useful in every technical trading chart as long as the market is open.
The Fibonacci Trading Sequence Indicator
The Fibonacci tools and methods can be traced back to a mathematical theory based on the work of Leonardo Fibonacci, who lived in the 12th century. Today’s Fibonacci indicators are based on the Fibonacci sequence of numbers. In this series, each number after 0 and 1 is the sum of the previous two.
It goes like this:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610….
And it is generated as follows:
- 0 + 1 = 1
- 1 + 1 = 2
- 1 + 2 = 3
- 2 + 3 = 5
- 5 + 8 = 13
Dividing any two subsequent numbers yields approximately 0.618, meaning every two numbers in this series is spread out at a ratio of around 1.618. The 1.618 ratio is also known as the Phi or golden ratio:
- 55 / 89 = 0.617
- 233 / 377 = 0.618
- 144 / 233 = 0.618
But wait, there’s more. There’s also a correlation between every number in the sequence with the one two steps ahead in the series:
Fibonacci went even further and also noted that every number in the series was roughly 23.6% of the third number to its right:
Surprisingly, the golden ratio frequently pops up in nature. Perhaps that’s why 1.618 is called an irrational number. It has been found that the shells of mollusks grow annually following the golden ratio. The same applies to the arrangement of leaves on a stem, the spiral on sunflower seeds, and even the cardiac cycle of the human heart. Bizarrely, it seems like nature likes the 62/38 arrangement, and considering the duplicative nature of humans, the golden ratio is a prominent fixture in trading.
Building on the above, the Fibonacci levels used in trading are derived from the relationship of the numbers in the Fibonacci sequence. Basically, there are three important levels used in the Fibonacci retracement: 23.6%, 38.2%, and 68.2%.
Although not one of the numbers in the Fibonacci series, the 50% level is nonetheless critical and therefore part of the retracement ratio widely used by traders.
Common Fibonacci Indicators
Out of these Fibonacci sequences, popular Fibonacci-based indicators include:
Fibonacci Arcs, which are dynamic half circles or arcs that extend from the baseline to the defined swing high and low, intersecting with the line at 23.6%, 38.2%, 50%, 61.8%, and 78.2% levels. This indicator is a function of price and time. The longer the baseline, the wider the arc. Like Fibonacci retracement levels, each point of the arc is a potential support or resistance.
Fibonacci Fans consist of trend lines drawn according to the Fibonacci ratios. The trend lines pass through reference points determined by the Fibonacci retracements. Used correctly, Fibonacci fans can be timely in projecting possible price retracements or extensions within a channel.
Fibonacci Time Targets are vertical lines spaced out according to the Fibonacci number sequence (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987), starting either from a trough or peak and subject to the prevailing trend. Each number represents a period. In the daily chart, the first time zone (or period) is one day, and in the hourly chart, it’s one hour. Different from other Fibonacci-based indicators, this indicator eliminates price and instead uses time as a basis for projection.
How to Trade Using Fibonacci Levels
As mentioned above, the Fibonacci levels are linked with potential support or resistance. Over time, traders tend to use them because they are aesthetically pleasing and when used correctly, Fibonacci-based indicators often eliminate subjectivity.
Drawing a Fibonacci retracement tool between a given trade range creates potential reaction levels, derived from the aforementioned Fibonacci ratios.
The retracement levels are generated when the trend baseline is divided by the Fibonacci ratios of 23.6%, 38.2%, and 61.8%. Afterward, horizontal lines are drawn from these points of intersection, generating a grid that aids traders in determining possible reversal points. Traders can then subsequently use these levels to either make a profit or place stop-loss orders.
How to use Fibonacci Retracement in Crypto Technical Analysis
Suppose the prevailing Bitcoin trend is bullish and the XBTUSD prices are correcting. If a Fibonacci retracement is drawn between a given trade range, a trader can project possible support based on any of the above three Fibonacci ratios and plan accordingly. A reaction at 38.2% may prompt the trader to place limit orders around this reaction level. As a safety net, the stop loss would just be below the 50% Fibonacci mark.
If the retracement is deep, and assuming the prices sink more than 50% from the recent swing high, then traders are safe placing limit orders between the 50% and 61.8% Fibonacci retracement levels with fitting stop-loss orders just below the 61.8% retracement mark.
However, note that the risk-reward ratio should ideally be 1:3, with a maximum recommended risk of 5%, when trading derivative products. The general rule of thumb is that traders should place their profit targets at the 131.8% extension level if the reversal was from 31.8% Fibonacci retracement. In the same vein, profit targets should be at the 161.8% extension mark if the prices found support from the 50% and 61.8% Fibonacci retracement levels.
While it has been irrevocably proven that Fibonacci retracement levels can aid traders, traders must take it upon themselves to complement this tool with other indicators. Since trading is all about supply and demand, studying candlestick arrangements, trading volumes, trend lines, and moving averages further helps traders identify potential entry or exit points.
Fibonacci ratio trading or Fibonacci pattern trading is all about capitalizing on trend continuation. It has been found that any retracement that is 38.2% or less indicates strong underlying momentum. On the other hand, deep corrections beyond the 68.2% level lead to a ranging or choppy market.
Traders relying on the Fibonacci tool, either alone or in tandem with other technical indicators, can either adopt an aggressive or a conservative trading style. In adopting an aggressive trading approach, traders with hindsight and confidence in trend resumption can place a limit order at any of the three key Fibonacci retracement levels in anticipation of trend continuation. More conservative, risk-averse traders should first align with the prevailing trend before placing short or long limit or market orders once the prices recoil from the key retracement levels.
Combining Fibonacci Trading Tools with Other Indicators
Reiterating the above point, given that Fibonacci tools can only guide entry and exit points, this is how you can use Fibonacci retracement and extension tools in combination with other technical indicators, such as moving averages, Elliot Waves, MACD, and more.
1. Using Fibonacci and MACD:
For better entry, traders must first identify the current trend. If it is bullish, then in a retracement, the entry points would likely be around the 23.6% or 38.2% zone if the trend is strong and around 50% and 78.2% levels if the retracement is steep.
Bullish entries will print once there is a bullish crossover on the MACD. Depending on the reversal points, stop-loss orders will be below either the 50% or 78.2% level, with targets at the 138.2% or 161.8% Fibonacci extension levels.
2. Using Fibonacci and Stochastic Indicator:
Like the MACD, the Stochastic is a momentum-based indicator. To fine-tune trade positions, the entry and exit points will depend on whether the reversal is printing at the overbought or oversold territory.
Any bullish (or bearish) signal that forms around the Fibonacci reaction points at the oversold (or overbought) territory will hint at demand (or supply). As such, traders can buy (or sell) dips (or pullbacks), with the first target at either the recent swing high or the 138.2% or 161.8% Fibonacci extension level, depending on the initial Fibonacci retracement level.
3. Using Fibonacci and Trading Volumes:
The cool thing about trading volumes in cryptocurrency trading is that they are real time and do not lag like, for example, the MACD or moving averages. Demand is marked by swelling trading volumes, while periods of accumulation or distribution are shown by shrinking volumes.
To combine this useful indicator with Fibonacci tools, traders must first identify the swing high and low from the existing trend. Afterward, any price reversal at the 38.2%, 61.8%, or 78.2% levels accompanied by a sharp increase in participation hints at a possible main trend resumption.
In that case, the trader would trade in the direction of the trend with a fitting stop-loss order determined by the Fibonacci retracement levels and profit-taking order generated from the Fibonacci extension levels.
It is clear that trading based on Fibonacci ratios can be immensely beneficial. With proper use of Fibonacci ratios, traders can determine possible reaction points where they can place entry orders or take profits when they sync with the main trend. However, this is not to say that the tool is infallible. Like other strategies and tools, Fibonacci indicators have their pitfalls.
Sometimes, the Fibonacci indicators can lead to unwarranted expectations, and when traders throw caution to the wind by adopting an aggressive strategy, they will be unknowingly exposed to risk. Therefore, prudence demands Fibonacci-based indicators be used in conjunction with other tools or signals for the best results and ultimately the best ROI gauged over time. On Xena Exchange, aside from support for a number of Fibonacci indicators, there are other platform-specific indicators that can further help traders make better trading decisions. Traders can combine any of these readily available indicators with any of the Fibonacci tools and comfortably trade derivative product(s) or supported cryptocurrency pairs with confidence.
The information provided in this article does not constitute investment advice.
Remember that trading cryptocurrencies comes with significant risks. You may suffer considerable losses and may potentially lose more than you have invested. No tool can guarantee future profits or predict market movements with absolute precision.
The company is not responsible for any damages or losses that occur in connection with the use of the information contained in this article.
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