There is no doubt that the Fibonacci indicator is one of the most popular tools.
Traders use it to find potential correction levels in trending markets. In this article, we look at how Fibonacci levels can be used in trading.
The Fibonacci sequence was discovered in Italy in 1170 by the Italian mathematician Leonardo Pisano. Simply put, in the Fibonacci sequence, each number is equal to the sum of the first two numbers. The sequence starts from 0 and 1, and is 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 and so on.
The interesting thing about this sequence is that when you divide the previous number in the sequence by its next number, you always get the same ratio of 0.618. For example, 34/55 is equal to 0.618, and all of 55/89, 89/144, and 144/233 are 0.618. This ratio is also called the golden ratio and can be observed in various natural phenomena.
And if you divide a number by the next number, you get the same ratio of 0.382. For example, 13/34, 21/55, 34/89, 89/233 are all true.
Traders use these ratios in trading to find possible price pullback positions and possible support and resistance areas.
Trend and price correction
Fibonacci has a lot to do with trends. Fibonacci ratios can help us identify where the price correction may end. The market is either showing trends or consolidation.
According to Dow Theory, price corrections usually reach the 50% level of initial fluctuations. Although this is not from the Fibonacci ratio, we can see that the Fibonacci tools provided by most trading platforms still include the 50% level (for the related article, read “Technical indicators 100 years ago, why are they still obsessed by traders today?” “).
How to apply Fibonacci levels in the chart?
To apply Fibonacci tools on a chart, the first step you need to do is to identify a strong movement in the trend. This is the most difficult step, because different traders may recognize different fluctuations and get different Fibonacci levels.
In an uptrend, strong volatility means that the price increases without obvious correction; in a downtrend, strong volatility means that the price falls without obvious correction. As your experience increases, it will be easier for you to recognize such strong fluctuations and apply Fibonacci levels.
If a strong fluctuation is identified, draw the Fibonacci tool from the bottom to the top of the fluctuation.
The Fibonacci tool will automatically draw the most important levels of 23.6%, 38.2%, 61.8% and 50%. If the price complies with a certain Fibonacci level, then the trader can open a position and set a stop loss below that level.
Use Fibonacci extensions for profit goals
In addition to identifying potential reversal areas for price corrections, Fibonacci tools can also be used to identify take profit targets. These targets are based on Fibonacci extension levels, the most commonly used are 123.6%, 138.2%, 161.8%, and 261.8%. These extension levels are Fibonacci retracement levels drawn by extensions in the direction of the trend
Combine Fibonacci levels and oscillations
I have to point out that although there are many applications of Fibonacci levels, we should not rely solely on Fibonacci retracements and extension levels to trade. If it can be used in combination with other technical tools, such as trend lines, chart patterns, channels or technical indicators, then Fibonacci tools will bring us better results.
Fibonacci retracement tools can help identify potential price reversals. At this time, we can combine oscillations to see whether the market is overbought or oversold at a certain level of retracement. This allows us to further confirm trading opportunities.
Is the Fibonacci level reliable?
Just like other technical tools, neither Fibonacci extension nor retracement levels should be used alone. We need to combine other technical tools to further confirm trading opportunities, including some chart patterns, candlestick patterns, fundamental analysis, etc.
The key to good use of Fibonacci levels is to correctly identify strong fluctuations in the trend. The stronger the volatility and the stronger the current trend, the more traders will be able to notice the interaction between price and Fibonacci levels.