This is a guide to trading with Fibonacci numbers. There are many tools based on Fibonacci. You will learn how to use the most popular such as Fibonacci retracements, Fibonacci Extensions, and Expantion. You will also learn how to create a trading plan based on the Fibo tool.
What is Fibonacci?
The Fibonacci sequence is a series of numbers where a number is found by adding two numbers before it. Starting from 0 and 1, the sequence progresses to 0, 1, 1, 2, 3, 5, 8, 13, 21, 34 and so on.
What is the use of the Fibonacci sequence?
It is a sequence discovered in the 13th century by the Italian mathematician Leonardo Fibonacci? The sequence is at infinity from 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55 and 89. The sequence has a series of interesting properties. The sum of any two consecutive numbers is equal to the next highest number.
What is the Fibonacci number
Fibonacci numbers are following integer sequence called the Fibonacci sequence. And are characterized by the fact that each number after the first two is the sum of the two precedents. Often, especially in modern usage, the sequence is expanded by another initial term:
Fibonacci spiral: an approximation of the golden spiral, created by drawing rounded corners that connect opposite corners of squares in Fibonacci tiling; It uses squares of sizes 1, 1, 2, 3, 5, 8, 13, 21 and 34.
What is Fibonacci expansion?
Levels used in Fibonacci retracements to forecast areas of support or resistance. Extensions are made up of all levels that go beyond the standard 100% level and are used by many traders to determine the areas where they would like to take advantage. The most popular expansion levels are 161.8%, 261.8%, and 423.6%.
What is the meaning of retracement?
There is a temporary reversal in the direction of the price of a retails stock that goes against the prevailing trend. A retracement does not indicate a change in the larger trend.
And two numbers to the left of 34 are 21 and 13. Therefore, we add 21 to 13 and result in 34. This is the answer to where the Fibonacci numbers came from. Each Fibonacci number in the sequence has its own place. A sequence is a basis for calculating other Fibonacci numbers, such as ratios or expansions.
What is Fibonacci Retracement and Ratio?
Based on the sequence, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 337, 610, 987…
We can calculate the ratio. The Fibonacci ratio is calculated by dividing a number by the order that follows it in sequence. Let’s look at some examples:
5/8 = 0.625
13/21 = 0.619
89/144 = 0.618
The final ratio listed: 61.8% is the most important ratio and is often called the golden ratio.
89/144 = 0.618
0.618 * 100 = 61.8%
Also, there are some other ratios, let us see how they come
For example, two places 21 to the right of 8 are: 8/21 = 0.38
Three places 8 through 33 are: 8/33 = 0.24
Here we have their most significant ratio: 23.6%, 38.2%, 61.8%. A ratio is also called a retracement level. This is because there is a chance that value will stop at one of those levels and reverse. Traders prefer to use certain levels more, so the list of the most popular full retracement levels is as follows
The Fibonacci Retracement Level
How to make a Retracement level (ABC)?
However, in most cases, the price moves in zigzag shapes. Some traders call it wave, and have a scientific concept known as Elliot wave theory. But for us, it is important to know the nature of these tricks. First, we need to identify a swing move that is a move from point A point to B. We already know that after the main swing there should be an improvement in the opposite direction to point C. When we see a step from point A to B, we wait for a move down (correction). C. Point C must be located between point A and B. This may look like depicting an uptrend on a chart
Should the price touch the retracement levels?
This is always a problem for new investors. They feel that C point is only valid when the price touches this Fibonacci level, it’s wrong. Fibonacci Retracement is a great tool, but not 100% accuracy. Sometimes the price closes near the retracement level and it can still be a valid move.
What retracement levels should I use?
This is initially very misleading because there are many Fibonacci retracement levels and some people use only specific ones, while others prefer to draw all the retracement. My advice is to try using standard levels. Over time, as you gain more experience, you will decide which one’s are the most important and which ones you prefer to use.
So, at what level should you start?
23.6%, 38.2%, 50%, 61.8%, 78%, 88.2%.
Why use 50%? This is not a Fibonacci retreatment, but still a significant level because it’s half of Fibonacci. So traders prefer to keep this level with other appropriate levels.
When should I open a trade?
This is the biggest challenge after pulling the correct retracement levels. With the Fibonacci Retracement Tool after pulling the retracement level, you should decide when you want to open your position. You have three options to choose from,
We have confirmed that the main trend should be strong. After a high swing from A to B, there was a strong correction, so we have drawn the retracement levels. We are waiting to take a long position as the main trend is up.
You look for the best risk reward ratio or you want to trade between A and B. For example, when the price reaches 61.8%, you go to this level for a long time or slightly above it. This level is very popular among traders and it works on many occasions.
You can take the same action at 50% or 38.2% if you think the correction ends there.
You look for or near the entry line that you think is point C. Your stop loss is rather tight, so your risk reward ratio is very good.
The other option is to wait and see how the price reacts with the retracement level and you wait for confirmation. This can be many things, such as confirmation from an oscillator or moving average or price pattern.
In the third case, you wait until the price breaks above the recent high (which you have used to attract your retracement level – point B).
Where to put stops?
Fibonacci Retracement is very good when it comes to keeping stop loss. Suppose you have opened a long position after correction at point C, where should you place the stop-loss order? I like to place it at point A, that is, below the location where the swing step started. If the price moves back below point A, there is probably something wrong with the trend strength.
Below, I have identified 3 possible locations where you can place your stop loss order in such a case:
It all depends on how aggressive you want to trade. Sometimes I keep the stop loss just 78% below the retracement line. If you want to reduce the loss of the tide, you place it below the points you think your point is c.
The good thing is that, over time, you will be able to understand the price behavior better and you will be able to put stop loss in better places.
The retracement with trend lines confirmation
Sometimes prices trend very well and it is easy to see the trend line. In such a case there is a strong possibility that when it comes to improvement, it will end up at the Fibonacci retreatment level closest to the trend line.
Fibonacci works very well in trending markets, so it is a good idea to combine the Fibonacci Retracement Tool with trendlines. First of all, you have to draw a trend line.
Let us assume that you are waiting for this line. Meanwhile, you can also pull the Fibonacci retracement level from low to high swing.
The correction ended at 61.8 retracement level and the price touched the trend line. As it turned out, it was a great point to enter the trade.
You placed your stop below the loss trend line, but not far from it. With a strong trend in place, you consider it a low-risk entry.
This does not always work well, but sometimes it does. You have to be very cautious about this type of price behavior, as these are good points for entering a trade. The potential risk of loss is small and the potential gain is large.
The Fibonacci retracement and support
Another great way to predict where a price move may end is by combining retracement lines with support levels. This is very easy to do. First of all, you have to see whether the retracement has a significant support/resistance level. We seek some form of support. This may be a support from the previous significant high, such as in the example below:
We can make the swing and correction very fast, down to 61.8%. If you take a closer look, the correction almost ended on the blue line, which now served as a support (because before that the price had closed above that line).
The Fibonacci retracement and EMA support
Another great way to look for support is to use the Fibonacci Retracement tool with moving averages. You probably know that some popular averages work well as support and resistance.
What are these moving averages? They are 20, 50, 100, 150 and 200 periods long.
Some traders may say that the more important are the averages, but this is something that you should decide based on your trading style. From the above set of averages, the most important ones are the longest: 50, 100, 150 and 200.
Take a good look at this combination, because, on many occasions, it is a good place to enter the trade. Not all traders use the Fibonacci retracement for an entry. Some traders enter or revaluate a trade on a moving average because they know that it is good support. You should join this group, but only if you have one more confirmation from the Fibonacci retreatment.
The Fibonacci Projections
There are two similar tools of the project where the move may end:
- Fibonacci expansion
- Fibonacci extension
This is initially confusing, but I’m going to explain the main differences so that you can make a good sense of the subject.
The Fibonacci expansion
Let’s start with the Fibonacci expansion, which is based on three points. To pull it, we have to identify swing low or swing high and correction. Yes, it is exactly the same as it was with retracement and looking for A, B and C. We use the same ABC point. As you remember, we have to identify swing and correction. Points A and B are marked at the swing end, C is at the point where the correction ended.
The Fibonacci extension
The Fibonacci extension is based on the first move (A to B). Point C is not used for calculation here.
The level of the fib is drawn from point B.
For example, a 138.2% expansion level equals a 38.2% distance between A and B, drawn from point B. Take a closer look at the chart below, where I have marked the distance:
For the 161.8% expansion line, we take the distance of 61.8% between A and B and connect it to point B.
Now you can see the point C (where the correction ends) does not matter in the calculation. We only care about the swing from A to B and this is our basis for calculating extension lines.
It may seem that this method is less accurate because for expansion we use 3 dots. The truth is that it is very accurate despite the difference in calculations. Personally, this is my favorite way to look for value projection and later in this guide I will mostly use this method.