Fibonacci Retracements and Technical Trading
Among the many tools that technical traders utilize, none is more prized than Fibonacci retracements and extensions. By now, I'm sure that most traders are at least vaguely familiar with the origin of the Fibonacci sequence. If not, here is the quick version; mathematician Leonardo Fibonacci identified the sequence in the 13th century. He was actually trying to calculate how many rabbits he could breed when he discovered this sequence of numbers. Nonetheless, the Fibonacci sequence has become the basis for many applications in our society. Today we will be discussing how the Fibonacci sequence is utilized in various aspects of trading.
This sequence isn't nearly as important as the mathematical relationship between the numbers in the sequence. The Fibonacci retracement numbers used in trading are derived by dividing the prior number in the sequence by the next number. For example: 61.8% is a very important number in the Fibonacci sequence for traders, 55/89 = 0. 6179 and hence you arrive at the Fibonacci retracement number of 61.8. There are other important Fibonacci retracement numbers and they are 38.2%, 50%, and 61.8%. These are the most common numbers used by traders.
Generally speaking, traders will draw a line from peak to trough, or trough to peak, depending on whether the market is moving up or down. They will then calculate where 38.2%, 50%, and 61.8% fall on that line drawn. These days though, nearly every charting program automatically calculates these Fibonacci retracement levels and inserts them for the trader.
There is no sound theoretical backdrop for why these numbers are so important in trading. Some traders feel that the Fibonacci retracement numbers are natural stopping points for price movement based upon trader emotion, while others believe that because of the widespread use of Fibonacci retracements the market responds as a self-fulfilling prophecy. In my trading days I have listened to countless arguments as to the legitimacy of the Fibonacci retracements system. There can be no doubt that the market, more often than not, tends to respect these lines. Of course, the reason they respect these lines is not entirely clear.
But does it really matter?
In my trading, I do not concern myself with the "whys" of Fibonacci retracements as it is unimportant to me. The facts are simple; the market typically pays close attention to these lines and therefore I pay close attention to the lines. In essence, it is a chicken and egg argument. I don't care if the chicken came first, or the egg came first, I know that these lines are of importance and I regularly chart them.
The lines formed by the Fibonacci retracements are generally referred to as support and resistance. Support refers to the levels to the downside that the market moves, and resistance is the point where the price stops when moving upward.
Does the market always respect Fibonacci retracement price levels?
Unfortunately, the answer to this question is no. This is one of the confounding aspects of Fibonacci trading. While the market often, even usually, respects the price levels of the sequence, there are times when the market blasts through the support and resistance line as if they were not even there. So often times the trader is forced to decide whether the market is actually trading through the resistance levels or going to honor the resistance levels. It can be a tough call, at times. By and large though, the market pauses (at the very least) at the Fibonacci levels.
In summary, we have looked at the way the Fibonacci sequence was discovered in learn how to calculate the Fibonacci retracement levels. Generally speaking, these levels represent support and resistance when they are drawn from peak to trough, or trough to peak. It is unclear exactly why Fibonacci retracements function as they do, but they function with enough frequency that they draw the attention of most traders, especially technical traders.
Questions and Answers
Fibonacci Lines or 'retracements' as they are sometimes called are a popular trading tool used to identify areas of support and resistance in the market. Fibonacci levels are particularly useful in highlighting areas the market is likely to pullback to to following a strong directional move. Identifying Fibonacci levels provides an opportunity to profit from the pullback or alternatively an entry point to rejoin a major trend.
So while constructing Fibonacci Retracement and Extension levels we will start from point A and consider B as the end of the move. Considering the move AB as 100%, suppose AB is 100 pips. If the market bounces back at 0.382%, we say the retracement was 38.2% or 38 pips. If it bounces back from 50% we say the retracement was 50% or 50 pips and if it retraces back from 0.618%, we say the retracement was 61.8% or 61 pips.
Fibonacci is like a friend to many traders when it comes to technical analysis. Fib retracement gave birth to Fibonacci extensions. Then came many other Fibonacci tools like Fibonacci Arcs, Fibonacci Fans and Fibonacci Time zones. All of these tools using Fibonacci sequence of numbers in various models. Let's try to see where we should put our bets
Leonardo Fibonacci was a mathematician who lived from about 1175 AD. He was well known in his day and contributed to the world of mathematics and his Fibonacci number sequence is used a lot in forex trading to increase profit potential - let’s look at it.
Fibonacci is known for discovering a series of numbers that was called after him the Fibonacci numbers or the Fibonacci sequence.
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