Introduction

Traders can use a variety of technical analysis (TA) tools and indicators to try and predict future price trends. This can include complete market analysis frameworks such as the Wyckoff Method, Elliott Wave Theory or Dow Theory, but can also include some technical analysis (TA) indicators such as Moving Averages, Relative Strength Index (RSI), Stochastics Relative Strength Index, Bollinger Bands, Ichimoku equilibrium chart, parabolic indicator and exponential moving average (MACD).

The Fibonacci Retracement tool is a commonly used indicator by thousands of traders in the stock, forex and cryptocurrency markets. Interestingly, it is based on the Fibonacci sequence discovered over 700 years ago.

This article will explain what the Fibonacci Retracement tool is and how to use it to find important levels on your charts.

What is Fibonacci Retracement?

Fibonacci retracements are a tool used by technical analysts and traders to predict areas of interest on charts. They do this by treating Fibonacci ratios as percentages. The Fibonacci retracement tool originates from a sequence of numbers discovered by the 13th-century mathematician Leonardo Fibonacci. This series of numbers is also called the Fibonacci sequence. Specific mathematical relationships between numbers in this sequence create ratios, which are then plotted on a chart. These proportions are:

• 0%
• 23.6%
• 38.2%
• 61.8%
• 78.6%
• 100%

Although 50% is not technically a Fibonacci ratio, some traders still believe that this level has certain Meaning because it represents the midpoint of the price range. Fibonacci ratios outside the 0-100% range can also be used, such as 161.8%, 261.8% or 423.6%.

We will discuss how traders use these percentages, but the main point is that the levels they outline can be related to important levels in the market. When plotted onto a price chart, Fibonacci levels can be used to identify areas of interest such as support, resistance, retracement zones, entry points, exit points, and stop-loss levels.

How to Calculate Fibonacci Retracements

Since these percentages are found in each Fibonacci Retracement tool are the same, so you don't need to calculate anything manually. However, the way to get them is to start with the Fibonacci sequence.

Let's create a sequence of numbers starting from 0 and 1, and keep adding the sum of the previous two numbers to the current number. If you add it infinitely, you will get a series of numbers called the "Fibonacci Sequence".

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987...etc. 

Of course, these numbers are not plotted directly onto the price chart. However, the levels used in the Fibonacci Retracement tool are to some extent derived from these numbers.

Excluding the first few digits, if you divide a number by the number after it, you get a ratio close to 0.618. For example, dividing 21 by 34 gives 0.6176. If you divide a number by the number second to the right, you get a ratio close to 0.382. For example, dividing 21 by 55 gives you 0.3818. All ratios in the Fibonacci Retracement tool (except 50%) are based on some calculations of this method.

Fibonacci Sequence and Golden Ratio

As mentioned above, Fibonacci The sequence of numbers was proposed by the mathematician Leonardo Fibonacci in the 13th century. The golden ratio (0.618% or 1.618%) is a mathematical ratio derived from these numbers. Why is it such an important number?

The Golden Ratio describes the proportions of some amazing phenomena in the universe, which can be seen everywhere in nature. Think of atoms, stars, galaxy formations, seashells, even bees - objects from the smallest to the largest may follow this proportion.

What’s more, artists, engineers and designers have used it for centuries to create works that are pleasing to the eye. From the pyramids to the Mona Lisa to the Twitter logo, many famous works of art and design have used the golden ratio in some way. It turns out that this ratio may also have significance in financial markets.

How to use Fibonacci Retracement

Now that we understand what the Fibonacci Retracement tool is What and how it works, next, we consider its use in financial markets.

Typically, this tool is drawn between two important price points, such as a high and a low. This range was then used as the basis for further analysis. Typically, this tool is used to plot levels within a range, but it can also provide insight into important price levels outside the range.

This range is usually drawn based on the underlying trend. Therefore, in an uptrend, the low is 1 (or 100%) and the high is 0 (0%). By drawing Fib retracements on an uptrend, traders can get an idea of potential support levels that might be tested if the market begins to pull back - hence it's called a pullback .

In contrast, in a downtrend, the low is 0 (0%) and the high is 1(100%). Note that the price is in a downward trend. So, in this case, a pullback refers to a movement (rebound) from the bottom. Against this backdrop, the Fibonacci retracement tool may provide insight into potential resistance levels if the market begins to rise.

Want to start your cryptocurrency journey? Go to Binance and buy Bitcoin now!

What can Fibonacci levels tell traders?

Traders can use Fibonacci levels to identify potential entry areas, price targets, or stop-loss points. This can vary significantly depending on personal setup, strategy and trading style.

Some strategies involve taking profits in the range between two specific Fibonacci levels. For example, consider a pullback following an uptrend. Buying at the 38.2% retracement and then selling at the 23.6% level could be an interesting strategy. Of course, this is highly dependent on personal strategy and many other technical factors.

Fibonacci levels are also often used in conjunction with Elliott Wave Theory to find correlations between wave structures and potential areas of interest. This can be a powerful strategy for predicting the magnitude of pullbacks in different swings of a given market structure.

Like other methods, the Fibonacci Retracement tool works best when used in conjunction with other technical analysis indicators. A signal that was not originally a buy or sell signal may become a buy or sell signal if confirmed by another indicator. Therefore, when price reaches a specific Fibonacci level, it may reverse or it may not. Therefore, it is crucial to manage risk, taking into account market conditions and other factors.

Fibonacci Extension

As mentioned above, Fibonacci levels are available for evaluating retracement or rebound areas (number 1 in the animation below). But beyond that, the Fibonacci sequence can also be used as a way to gauge potentially important levels outside of the current range. These are called expansion levels (see number 2).

Fibonacci extension levels may be considered as potential trading targets. Each trader can choose a different expansion level as a target (or multiple targets). The first few expansion levels are 138.6%, 150% and 161.8% – followed by 261.8% and 423.6%. Therefore, Fibonacci extension levels may signal the end of the next price move.

Summary

Fibonacci numbers can be found throughout nature and many traders consider them useful when charting financial markets Be relevant.

However, as with all technical indicators, the relationship between price action, chart patterns, and indicators is not based on any scientific principles or laws of physics. Therefore, the usefulness of a Fibonacci retracement tool may be related to the number of market participants paying attention to it. So even though Fibonacci retracement levels don't necessarily correlate to anything tangible, they can serve as a tool to try and predict areas of interest.