Fibonacci

Fibonacci retracements are popular among technical traders. They are based on the key numbers identified by
mathematician Leonardo Pisano, nicknamed Fibonacci, in the 13th century. Fibonacci's sequence of numbers is not
as important as the mathematical relationships, expressed as ratios, between the numbers in the series. In technical
analysis, a Fibonacci retracement is created by taking two extreme points (usually a peak and a trough) on a stock
chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. Once
these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels.

Key Takeaways:

 Fibonacci retracements are popular tools that traders can use to draw support lines, identify resistance levels,
place SL orders, and set target prices.

 A retracement is created by taking two extreme points on a chart and dividing the vertical distance by the key
Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.

 Fibonacci retracements suffer from the same drawbacks as other universal trading tools, so they are best
used in conjunction with other indicators.

How Fibonacci Ratios work:

The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this
sequence is simply the sum of the 2 preceding terms, and the sequence continues infinitely. One of the remarkable
characteristics of this sequence is that each number is approximately 1.618 (Phi, Golden Number) greater than the
preceding number. This common relationship between every number in the series is the foundation of the ratios used
by technical traders to determine retracement levels.
The key Fibonacci ratio of 61.8% is found by dividing one number in the series by then umber that follows it. For
example, 21 divided by 34 equals 0.6176, and 55 divided by 89 equals about 0.61798.
The 38.2µ ratio is discovered by dividing a number in the series by the number located two spots to the right. For
instance, 55 divided by 144 equals approximately 0.38194.
The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For
example, 8 divided by 34 equals about 0.23529.

Fibonacci Retracement and Predicting Stock Prices

For unknown reasons, these Fibonacci ratios seem to play a role in the stock market, just as they do in nature.
Technical traders attempt to use them to determine critical points where an asset's price momentum is likely to
reverse. The best brokers for day traders can further aid investors trying to predict stock prices via Fibonacci
retracements.

Fibonacci retracements are the most widely used of all the Fibonacci trading tools. That is partly because of their
relative simplicity and partly due to their applicability to almost any trading instrument. They can be used to draw
support lines, identify resistance levels, place stop-loss orders, and set target prices. Fibonacci ratios can even act as
a primary mechanism in a countertrend trading strategy.

Fibonacci retracement levels are horizontal lines that indicate the possible locations of support and resistance levels.
Each level is associated with one of the above ratios or percentages. It shows how much of a prior move the price has
retraced. The direction of the previous trend is likely to continue. However, the price of the asset usually retraces to
one of the ratios listed above before that happens.
Retracing a downtrend: 0% = bottom, 100% = top
Retracing an uptrend: 0% = top, 100% = bottom

Fibonacci Retracement Pros and Cons

Despite the popularity of Fibonacci retracements, the tools have some conceptual and technical disadvantages that
traders should be aware of when using them.

The use of the Fibonacci retracement is subjective. Traders may use this technical indicator in different ways. Those
traders who make profits using Fibonacci retracement verify its effectiveness. At the same time, those who lose
money say it is unreliable. Others argue that technical analysis is a case of a self-fulfilling prophecy. If traders are all
watching and using the same Fibonacci ratios or other technical indicators, the price action may reflect that fact.

The underlying principle of any Fibonacci tool is a numerical anomaly that is not grounded in any logical proof. The
ratios, integers, sequences, and formulas derived from the Fibonacci sequence are only the product of a mathematical
process. That does not make Fibonacci trading inherently unreliable. However, it can be uncomfortable for traders
who want to understand the rationale behind a strategy.

Furthermore, a Fibonacci retracement strategy can only point to possible corrections, reversals, and countertrend
bounces. This system struggles to confirm any other indicators and doesn't provide easily identifiable strong or weak
signals.

Mistakes to avoid:

Every FOREX trader will use Fibonacci retracements at some point. Some will use them just some of the time, while
others will apply them regularly. But no matter how often you use this tool, what’s most important is that you use it
correctly every time.

Improperly applying technical analysis methods will lead to disastrous results, such as bad entry points and mounting
losses on currency positions. Here we’ll examine how not to apply Fibonacci retracements to the FOREX markets.
Get to know these common mistakes and chances are you’ll be able to avoid making them – and suffering the
consequences – in your trading.

Key takeaways:
  A Fibonacci retracement is a reference in technical analysis to areas that offer support or resistance.

 The Fibonacci numbers come from an Indian mathematical formula which Western society named for
Leonardo Fibonacci, who introduced the concept to Europe.

 One common mistake traders make is confusing reference points when fitting Fibonacci retracements to
price action.

 New traders tend to take a myopic approach and mostly focus on short-term trends rather than long-term
indications.

 Fibonacci can provide reliable setups, but not without confirmation, so don’t rely on Fibonacci alone.

1) Don’t mix reference points.

When fitting Fibonacci retracements to price action, it’s always good to keep your reference points consistent. So, if
you are referencing the lowest price of a trend through the close of a session, or the body of the candle, the best high
price should be available within the body of a candle at the top of a trend: candle body to candle body; wick to wick.

Incorrect analysis and mistakes are created once the reference points are mixed – going from a candle wick to the
body of a candle. Let’s take a look at an example in the Euro/Canadian Dollar currency pair. The figure below shows
consistency. Fibonacci retracements are applied on a wick-to-wick basis, from a high of 1.3777 to a low of 1.3344.
This creates a clear-cut resistance level at 1.3511, which is tested, then broken.

The figure below, on the other hand, shows inconsistency. Fibonacci retracements are applied from the high
close of 1.3742 (35 pips below the wick high). This causes the resistance level to cut through several candles
(between Feb.3 and Feb. 7), which is not a great reference level.
By keeping it consistent, support and resistance levels will become more apparent to the naked eye, speeding
up analysis and leading to quicker trades.
2) Don’t ignore long-term trends.
New traders often try to measure significant moves and pullbacks in the short term without keeping the
bigger picture in mind. This narrow perspective makes short-term trades more than a bit misguided. By
keeping tabs on the long-term trend, the trader can apply Fibonacci retracements in the correct direction of
the momentum and set themselves up for great opportunities.
In the figure below, we establish the long-term trend in the British pound/New Zealand dollar currency pair
is upward. We apply Fibonacci level from 20.648 to 2.1235. This is a perfect spot to got long in the currency
pair.
But if we look at the short term, the picture looks much different:

After a run-up in the currency pair, we can see a potential short opportunity in the M5 TF (above). This is
the trap. By not keeping the longer-term view, the short seller applies Fibonacci from the 2.1215 spike high
to the 2.1024 spike low (Feb.11), leading to a short position at 2.1097, or the 38% Fibonacci level.
This short trade does net the trader a handsome 50-pip profit, but it comes at the expense of the following
400-pip advance. The better plan would have been to enter a long position in the GBP/NZD pair at the short-
term support of 2.1050.
3) Don’t rely on Fibonacci alone.
Fibonacci can provide reliable trade setups, but not without confirmation. Applying additional technical
tools like MACD or stochastic oscillators will support the trade opportunity and increase the likelihood of a
good trade. Without these methods to act as confirmation, a trader has little more than hope for a positive
outcome.
In the figure below, we see a retracement off of a medium-term move higher in the EURYEN pair.
Beginning on Jan 10, 2011, the EUR/YEN exchange rate rose to a high of 113.94 over almost two weeks.
Applying our Fibonacci retracement sequence, we arrive at a 38.2% retracement level of 111.42 (from the
113.94 top). Following the retracement lower, we notice the stochastic oscillator is also confirming the
momentum lower.
Now the opportunity comes alive as the price action tests our Fibonacci retracement level at 11.40 on Janv
30. Seeing this as an opportunity to go long, we confirm the price point with stochastic, which shows an
oversold signal. A trader taking this position would have profited by almost 1.4%, or 160 pips, as the price
bounced off the 111.40 and traded as high as 113 over the next couple of days.
4) Using Fibonacci for short-term
Day trading in the FOREX market is exciting, but there is a lot of volatility. For this reason, applying
Fibonacci retracements over a short TF is ineffective. The shorter the TF, the less reliable the retracement
levels. Volatility can, and will, skew support and resistance levels, making it very difficult for the trader to
pick and choose what levels can be traded. Not to mention in the short term, spikes and whipsaws are very
common. These dynamics can make it especially difficult to place stops or take profit points as retracements
can create narrow and tight confluences. Just check out the CAD/JPY example below.

In the above figure, we attempt to apply Fibonacci to an intraday move in the CAD/JPY exchange rate chart
(using three minutes for each candle). Here, volatility is high. This causes longer wicks in the price action,
creating the potential for misanalysis of certain support levels. It also doesn’t help that our Fibonacci levels
are separated by a mere six pips on average, increasing the likelihood of being stopped out.
Remember, as with any other statistical study, the more data used, the stronger the analysis, i.e., the longer
the TF, the better. Sticking to longer TF when applying Fibonacci sequences can improve the reliability of
each price level.

Correctly Using Fibonacci for Forex

Fibonacci analysis is useful for forex traders to identify hidden support and resistance levels. There are two ways to
apply Fibonacci methods to the forex market: Historical analysis and trade preparation. The first examines long-term
trends in the forex market to identify the levels that trigger major trend changes.

The second method is used to anticipate the levels of retracement or recovery for forex prices. In this case, traders
will place a Fibonacci grid over the chart of recent short-term price action, marking the various Fibonacci levels.
They will then place additional grids over shorter and shorter time intervals, looking for places where the harmonic
levels converge. These price points have the possibility of becoming turning points for price actions.

As with other forms of technical analysis, longer-term trends tend to be stronger than short-term ones. In other
words, a support level on a weekly chart tends to be more reliable than one on a daily chart.

What Is the Main Disadvantage of the Fibonacci Method?

Although Fibonacci retracements can sometimes be used to predict price movements, many traders find the
calculations too complex and time-consuming to use. Another disadvantage is that the results are too difficult for
most traders to understand easily. Some experts believe that the Fibonacci levels have more to do with herd
psychology than any innate property of the Fibonacci levels. As a result, traders should consider the possibility that
the Fibonacci method is actually self-fulfilling.

Which Are the Best Fibonacci Retracement Settings?

The most commonly used Fibonacci retracement levels are at 23.6%, 38.2%, 61.8%, and 78.6%. 50% is also a
common retracement level, although it is not derived from the Fibonacci numbers.

How Accurate Are Fibonacci Retracements?

Some experts believe that Fibonacci retracements can forecast about 70% of market movements, especially when a
specific price point is predicted. However, some critics say that these are levels of psychological comfort rather than
hard resistance levels.

The Bottom Line

As with any specialty, it takes time and practice to become better at using Fibonacci retracements in forex trading.
Don't allow yourself to become frustrated—the long-term rewards outweigh the costs. Follow the simple rules of
applying Fibonacci retracements and learn from these common mistakes to help you analyze profitable opportunities
in the currency markets.

Fibonacci Clusters:
 A Fibonacci cluster is where a collection of Fibonacci retracements or extension levels, based on various price
swings, convene near one price area.
 The theory of a cluster is that if multiple Fibonacci extension or retracement levels are near one price, that
price is likely to be an important S/R area.
 A trader could then potentially take a trade near that level.
Key takeaways:
 A cluster indicate that price could be at an important S or R area, or a turning point.
 Traders may opt to enter of exit trades around Fibonacci clusters.
A trader may draw retracement and extension levels on various TF. For example, they may draw a large one on a
weekly chart, then draw some on the smaller daily and hourly price swings.
With multiple Fibonacci levels all over the chart, some will cluster together near a certain price. This Fibonacci cluster
marks a potentially important area as a Fibonacci level from more than one price swing says that this area is likely to
be S or R.
The trader may then use this cluster area to trade from. If the price is in an overall downtrend, and there is a Fibonacci
cluster that says the price will stall out near a specific price on the next rally, the trader will watch to see if the price
does in fact stall out at that level. Then, if the price starts to drop again, they enter a short position.
Limitations of using Fibonacci clusters:
Fibonacci clusters won’t always indicate important areas or turning points on the chart. Price will often disregard these
levels entirely. Although, to the Fibonacci trader, this may provide information as it lets them know the price is
moving toward the next Fibonacci level(s).
An argument against Fibonacci analysis is that with so many levels, especially when using multiple Fibonacci
retracement or extension tools at the same time, the price is likely to turn near one of them. Only in hindsight is it
clear which of the many levels shown of the chart actually turned out to be significant. This is why awaiting
confirmation from the price is important. How the Fibonacci levels are drawn is also subject to debate. Some drawn
them based on high and low points, while others draw them based on closing prices, or a combination of the above.
This means traders may end up with clusters at a different price depending on how the tools are drawn.

Fibonacci Time Zones:

Fibonacci time zones are a technical indicator based on time. The indicator is typically started at a major swing high or
swing low on the chart. Vertical lines then extend out to the right, indicating areas of time that could result in another
significant swing high, low, or reversal. These vertical lines, which correspond to time on the x-axis of a price chart,
are based on Fibonacci numbers.

Key takeaways:
 TZ are vertical lines that represent potential areas where price may make a swing high, low, or reversal.
 TZ may not indicate exact reversal points. They are areas.
 TZ only indicates potential areas of importance related to time. No regard is given to price. The zone could
mark a minor high, or low, or a significant high or low.
Fibonacci times zones are the number from Fibonacci’s sequence, when added to the initial time selected. Thus, if we
choose a start date of April 1, this would be time (0). The first Fibonacci time zone vertical line will then appear on the
next trading session (1), the second will appear two sessions later (2), and then three (3), five (5), and eight (8) days
later, and so on.
If adding Fibonacci time zones by hand the first five numbers can be avoided, as the indicator is not particularly
reliable when all the vertical lines are packed together. Therefore, some traders start drawing their vertical lines 13 or
21 periods after their starting point.