Fibonacci Trading Tool
Fibonacci was a famous mathematician from the middle ages, born back in 1170 under the name Leonardo Pisano. Fibonacci studied mathematics in Bugia, the northwestern part of Algeria, where he learned more about the use of Hindu-Arabic numbers. Fibonacci used the model of the Hindu-Arabic numeral system to popularise its use in Europe when he returned to his home in Italy. He documented everything he learned and shared his insights on creating numerical sequences that were later named after him.
A Fibonacci sequence of numbers revolves around the rule that each number is approximately 1.618 times greater than the previous number. In a Fibonacci sequence, each number is the sum of the two previous numbers, starting with the sum of 0 and 1. In that fashion, the numeral sequence would appear like so:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610
with the sequence continuing to infinity.
The difference between these numbers represents the golden ratio, set at 1.618. This ratio is found in art, architecture, and even nature, describing the proportions of human anatomy, plants, animals, artistic and architectural masterpieces, and even galaxies.
Today, some of Fibonacci’s studies in mathematics are used in financial markets for trading. Matching the needs of traders who are looking for market insights, the Fibonacci’s sequence is not used in its original form. Instead, traders can take advantage of the relationship between Fibonacci numbers and sequences. Fibonacci levels were created to provide deeper insights into the momentum found in financial markets, forming retracement and extension levels.
How are Fibonacci retracement levels used for trading, and how can traders use these levels to form analyses and predictions?
What Is Fibonacci Retracement?
Fibonacci retracement is a trading tool popularly used in financial markets to create technical analyses and spot reversals in trends. When taking this tool into consideration, it is not the Fibonacci sequences that matter but the ratio between the numbers contained in these sequences.
Traders use Fibonacci retracement to determine stop-loss lines, find support and resistance levels, and predict target prices in financial markets. Fibonacci retracement is done when the bottom and peak values are found, based on which the price chart can be vertically divided by a Fibonacci ratio starting from 23.6% then going up to 38.2%, 50%, 61.8%, and 100%. Based on the key ratios and vertical lines drawn on the chart, support and resistance levels can be traced. Because these key ratios can describe the key points of trend reversals in the market, Fibonacci retracement is one of the most popular Fibonacci trading tools.
Fibonacci ratio starting at 23.6% then going up to 38.2%, 50%, 61.8%, and 100%
Fibonacci levels are fairly easy and simple to use, and they represent effective trading tools. However, it is best to use more useful metrics within the technical analysis to effectively determine entry points for maximum profit. Many trading tools, such as Tokens TradingView, have a smart drawing tool for Fibonacci retracements, as well as for Fibonacci extensions, that allow users to visually identify these levels on a chart. Both tools are fully customisable, and levels can be changed or added.
When it comes to using the golden ratio to determine support and resistance levels, many traders will go for a 50% ratio. This ratio allows more space for the price to move in both directions after a retracement.
Using Fibonacci Retracement Levels for Trading
Traders use the Fibonacci retracement strategy with the expectation that the price will get back to its initial trend after a retracement. Fibonacci retracement can be used on any timeframe, which is why it stands as one of the most popularly used and most useful trading tools.
Traders look into the price movement through an active trend, trying to take a low-risk position so that they can make a profit based on the retracement. The strategy revolves around predicting that the price will get back to its initial trend once it makes a turn in the form of a reversal. Fibonacci retracement uses the golden ratio to form trading lines, and traders include other technical metrics to make their analysis and predictions more accurate. Other used metrics in combination with Fibonacci retracement are usually candlesticks, trading volumes, moving average, and trend lines.
What is important to note when using Fibonacci retracement is that the timeframe matters in relation to the historical data and past price trends. For instance, a 60-day chart may tell you more about what you can expect to see in the future price movement than a one-day chart would. You can use Fibonacci retracement on any timeframe, including extended trading periods and single-day trends.
Fibonacci Extensions and Their Use in Trading
Fibonacci extensions can be used as a part of the retracement strategy to locate potential exit areas. When compared to Fibonacci retracement, which traders use to forecast retracement in prices and identify support and resistance level, extensions can predict profit targets, again based on key ratios. Key ratios for Fibonacci extensions are 61.8%, 100%, 161.8%, 261.8%, and 423.6%, presenting major and the most commonly used levels within this strategy.
In combination with Fibonacci retracement, extensions are used to determine how far the price may go after the initial retracement, providing traders with the opportunity to predict target prices.
Once extensions are drawn on the chart, there are three crucial points at which key ratios are applied. The first point is the start momentum, the second point shows the end of the price movement, and the third and final point shows the ending retracement against the price move. Ratios can be projected into monetary values (prices) to determine the final outcome of the market momentum—that is, the point of finding the target price.
The differences between the two first points can be multiplied by the golden ratio (1.618) or any other ratio, which will help the conversion of the ratio to dollars/euros to determine the target price.
Extensions and Fibonacci retracement should be used in combination with other key metrics for a more reliable technical analysis.
Trading with Fibonacci Trend-Line Strategy
Fibonacci trend-line is a trading strategy that many traders use to take advantage of Fibonacci retracement. Fibonacci retracement uses swing-high and swing-low candlesticks to effectively follow up with downtrends and uptrends isolated within active trends in financial markets. Swing-low is a type of a candlestick used for this strategy that displays at least a couple of the lower highs on both left and right sides. Swing-high is a candlestick comprised of at least two higher lows on both sides of the candlestick.
The Fibonacci trend-line strategy provides insight into the right time to buy or sell a position. Insight into swing-lows and swing-highs can help traders determine the points of value within trends. Swing-highs can be used to recognise trend reversals, showing that there would be a fall back from the current peak price.
The Fibonacci trend-line strategy provides insight into the right time to buy or sell
You can also use swing-lows and swing-highs to recognise uptrends and downtrends. If there is an uptrend in the market, you will be able to note that the price consists of higher highs and higher lows. A swing-low will indicate that the price will reach a low point before moving up.
When a trader is swing-low trading, they are looking to buy at lower prices. On the other hand, swing-high trading includes selling short to make a profit during a price reversal to a lower point.
Because traders can use these metrics to identify uptrends and downtrends, the Fibonacci trend line strategy can be used to spot a retracement within trends.
Fibonacci Retracement with Trend-Line Strategy
Fibonacci retracement can be used with the Fibonacci trend-line strategy to identify the right time to sell or buy positions. This strategy is often used in various types of financial markets, including cryptocurrency, Forex, stocks, futures, and other assets of value.
How to Use Trend Lines with Fibonacci Retracement
Once you can identify the active trend in the market (either downtrend or uptrend), you will need to create a trend line based on support and resistance levels, depending on whether the price is going up or down. Once the trend line has been created, you will need to use Fibonacci retracement. It should be placed on the swing-low and swing-high. The trend line will help traders determine the right time to make a move and either buy or sell positions.
What you are looking for is for the price to hit the trend line with stalling before it follows the trend back. If the price momentum happens to blow up the trend line by going beyond it and past 50%, 61.8%, and 78.6%, that means that the trend has been broken. If that happens, traders need to look for other tradelines to find the perfect opportunity to make a profit.
Even when the price hits the trend line, you need to wait for it to retrace before you act upon the trend. Otherwise, the trend may be broken after your move, which is how traders end up losing instead of gaining profit.
To be 100% certain that you have found the right trend, you need to spot Fibonacci’s golden ratio
The golden ratio is found between 38.2% and 61.8% within the trend line, which is how retracement is made, making it a favourable time to make an entry.
Based on the active trend, traders will buy positions when the price is heading towards closing the line above 38.1% of 50% trend line. Traders will sell their positions once the retracement is found when the price is closing below the trend line between 38.1% and 50%.
For more effective and efficient trades, traders also use trend lines and Fibonacci retracement to form stop loss. When using this strategy, you want to make an exit from your position if your predictions don’t turn out right, and the price doesn’t reach the point of retracement. It is always recommended to analyse past trends to determine the current support and resistance levels.
Fibonacci Retracement Pros and Cons
Many traders consider Fibonacci retracement one of the most useful tools, but some traders may point out that the advantage of using this tool is subjective based on the way it is used to predict price retracement, corrections, counter-trends, and price reversals. In combination with other technical indicators, Fibonacci retracement can be effectively used to form analyses because it allows traders to predict the price momentum based on support and resistance levels. Although a useful and rather simple trading tool, it is recommended to use other indicators to confirm the predictions and analysis formed by Fibonacci retracement levels, extensions, and trend lines.