First of all, I would like to point out in this series I will be covering Fibonacci retracements and extensions only for now. The reason being, I want to showcase the most simple and most mango way to implement Fibonacci into your own analysis.
Personally, I do not use these Fibonacci tools solely on their own, but in confluence with other indicators or methods of analysis which (I will touch on some briefly later in the series).
Fibonacci retracements come from ratios used to distinguish possible reversal levels, or support and resistance zones (S&R* zones). These ratios are from the Fibonacci Sequence.
A Fibonacci retracement is made up by taking a low and high point of a trend, then dividing the distance between them by Fibonacci ratios (23.6%, 38.2%, 61.8%). This plots out horizontal levels between the two anchor points.
A retracement can be seen as a pause in trend, or a higher time frame pull-back, which can be an edge for getting into larger trends at possibly better entries when used in a strategy with other indicators. A retracement is not a reversal, because, after a retrace, the price will usually continue in the same direction as the former trend.
Furthermore, retracements are a stationary tool so naturally, they give confluence with already priced in areas of support or resistance. But also price usually respects them more compared to other “reactive” or “lagging” indicators like Moving Averages because they are not reacting to price action and are fixed S&R*.
Each retracement level represents a Fibonacci percentage or ratio.
However, some traders may not strictly use numbers derived from Fibonacci, mainly as a personal preference. For example, I actually use 0.35, 0.5 & 0.65 as I have found these to add extra edge and confluence in my analysis’ which I will go over further in the series.
Simple Visuals for different Retracements:
Bullish Fibonacci retracement:
Price is trending up, and has a pause in the uptrend, essentially creating a higher low. Also seen as an opportunity in the market to enter longs at lower prices to position for another impulsive move upwards.
Also, any shorts may exit their positions around the same Fibonacci levels, as they anticipate a higher low. They want to get out before the price starts moving against them, especially if it’s a bullish trend.
Bearish Fibonacci retracement:
Price is trending down, and has a pause in the downtrend, essentially creating a lower high. Also seen as an opportunity in the market to enter shorts at higher prices for another impulsive move downwards.
Also, any longs may exit their positions around the same Fibonacci levels, as they anticipate a lower high.
The Most Common Retracements:
For now, I will provide examples of the most commonly found retracement levels (or ratios), and ones that I have found to be respected the most.
- 0.236 or a 23.6% retrace.
- 0.382 or a 38.2% retrace.
- 0.618 or a 61.8% retrace.
- 0.786 or a 78.6% retrace.
Additionally, you can implement a 0.5 or 50% retrace, although it is not a Fibonacci number, often traders will use it as a midline or median point between a swing high and low as it frequently gets well-respected as a level.
[ *Tip: I added two extra retracements to my tool, the 0.35 and the 0.65 values. The reason I do this is to simply mark out zones so I can more easily find confluence with other tools like analysing horizontal support/resistance from price action. ]
Fibonacci levels have been marked out on the chart below as a visual reference.
In this example you can see how after Bitcoin bottomed out in the $3-4k region, it manages to retrace and find resistance firstly at the 0.382 zones, then also rejects the 0.618 retracements (this was almost to the wick high perfectly). What previously is resistance is then used as support as it based right along the top of the yellow 0.382 zone before breaking below it and seeing a deeper correction.
I used this Bitcoin example as I know a lot of you reading this will be familiar with this particular chart, and for those who haven’t seen this Fibonacci retracement example before you may find it interesting, to say the least.
Calculating Fibonacci Retracement values:
23.6% – This is when you divide one number by another number three places to the right in the sequence. For example, if you do 13/55, or 21/89. These equal approximately 0.236 or 23.6%.
38.2% – This is when you skip a sequence in the division. For example, if you do 21/55, or 55/144. Another way to get it is: 0.618². These equal approximately 0.382 or 38.2%.
61.8% – This is when you divide the current number in the sequence with the next number (starting from 13). For example, if you do 34/55, or 55/89. These equal approximately 0.618 or 61.8%.
78.6% – Simply put, is when you get the square root of 0.618. For example √0.618.
0% and 100% are not actually Fibonacci numbers but represent the start (first anchor point) and the end of the retracement (second anchor point). 50% is midline or the median between the two.
Fibonacci extensions are ratios formed by the Fibonacci sequence, these ratios are applied to a high and low point that create extensions beyond the 100% retracement level (first anchor point).
Extensions are commonly used to establish projected areas of projected support and resistance that can form when assets are in price discovery (making new highs or lows), or where there is little/no price history for you to use obvious horizontal support and resistance lines (or other similar methods).
However, extensions can be used when a chart is not in price discovery as they can provide additional confluence to your levels using existing support and resistance zones or other indicators. (I will touch on some examples of this in another part of the series).
Simple Visuals for different Extensions:
Fibonacci extension – Uptrend:
Price is trending up (higher highs & higher lows) and has a pause in the uptrend, essentially creating a higher low. Once the higher low is confirmed, the price moves up past the previous high and beyond.
Extensions can become targets for longs to exit positions, or to take profits.
Fibonacci extension – Downtrend:
Price is trending down (lower lows & lower highs) and has a pause in the downtrend, essentially creating a lower high. Once the lower high is confirmed, the price moves down past the previous lows and beyond.
Extensions can become targets for shorts to exit positions, or to take profits.
The Most Common Fibonacci Extensions:
Here are some of the most common Fibonacci Extension ratios, I will point out the ones I would recommend as a start because you can always try new ones and implement them later. Ultimately you can decide which ones you would like to use, this is just a general guide to try to help narrow your focus.
- 1.272 or a 127.2% ratio.
- 1.414 or a 141.4% ratio.
- 1.618 or a 161.8% ratio.
- 2.36 or a 236% ratio.
- 2.618 or a 261.8% ratio.
- 4.236 or a 423.6% ratio.
As seen below, these are the Fibonacci extension levels I have decided to recommend for starting off.
This is a simple example of how to place an extension, you can see the values I have used here:
1.272, 1.618, 2.36, 2.618.
You can see how the price didn’t really respect the 1.272 level much, whereas with the other three extensions it respected them much more obviously (evident with the 2.618 around the top).
This is only a brief explanation of how you can use this tool in your technical analysis but I will give a deeper explanation & tutorial in the upcoming part of the series, ‘Diving into Fibonacci Extensions’.
Calculating some Fibonacci Extension values:
127.2% – Is the square root of 1.618: √1.618
161.8% – Divide the next number in the sequence with the current number (these are covered in Part 1 when explaining where the golden ratio comes from).
236% – This is from removing the decimal place from “23.6%” and making it “236%”.
261.8% – Divide a number by two places to the left in the sequence and it equals roughly 2.618.
Also calculated from 1.618².
423.6% – Divide a number by three places to the left and the ratio equals approximately 4.236.
Example: 377/89 = 4.23595.
Other extensions that show up are actually not derived from the Fibonacci sequence, but use existing Fibonacci numbers that are and add 100% or 200% etc to the number. For example, the 361.8% & 461.8% ratios are just using the base of the 161.8% golden ratio and replacing the first 1 with 3 and 4.
The reason these ratios still may work is that as an asset continues to go further into price discovery the higher the relevant extension ratios become. Often traders will use these more ‘uncommon’ extensions like 361.8% or 427.2% as they might be the only way to gauge potential points of support or resistance.
This should give you a decent starting point and overview of Fibonacci Retracements & Extensions, and hopefully, you have learnt something new.
Part 3 is the next in the series, and that is solely focused on Fibonacci retracements.
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