Fibonacci Retracement and Extensions [2022]
Fibonacci sequences are a series of numbers; they also go on to create the pattern or spiral known as the Golden Ratio, which is also known as nature’s number. Traders even found ways to incorporate it into their trades.
Main Points
- Fibonacci sequences are a series of numbers where the number is the sum of the two previous values.
- Fibonacci numbers are known as “nature” numbers since they appear a lot in nature.
- Since these patterns are present in nature, traders believe that they could also work for trading the financial markets.
- While Fibonacci tools are useful, they shouldn’t be heavily relied on. You could use them in conjunction with other indicators and price action to improve your trading, but the Fibonacci tools alone aren’t enough.
What do Fibonacci Numbers have to do with trading?
The numbers and patterns gotten from the Fibonacci sequence are shown all around the world and the universe. On a sunflower, each seed is 0.618 times larger than the previous one. If you divide any Fibonacci number by the previous number, then you will get 1.618.
Real world examples of nature following the Golden Ratio
- Spiral Galaxies
- Hurricanes
- Fruits and Vegetables
- Flower Pedals
- Pine cones
- Human beauty standards
Since the Fibonacci numbers are present in so many aspects of life, traders believe that they could also use the Fibonacci levels in the financial markets.
In my opinion, I believe that the Golden Ratio sequences in trading are just like a self-fulfilling prophecy, and if enough people think that it will happen then eventually it will “happen.” When it comes to the value of something, the main thing that determines the value of something is based on the psychology and emotions of the traders, or the buyers and sellers. It is simple: who buys and sells? They are humans; maybe they have a lot of liquidity, but they are still humans and have emotions, or not even that. Maybe it’s the masses that build up their liquidity and get into the same move. Even algorithms are still based on human emotions.
An example of a short with profits at the 0.618 price level that did a small bounce and eventually grabbed liquidity to go towards lower lows.
A possible scenario here could have been that many retail traders could have caused this move believing that it would happen and retrace to the 50% or 61.80% level, and then they shorted it and took profits. Someone or an entity with a lot of capital then on the second move could have used this information for their advantage, assuming retail traders entered on another short and then moved the market to trigger their stop loss to liquidate their positions and then short the market.
The logic of trading can be confusing; everything is pure theory, and no one will be 100% correct, but following logic and common sense is much more useful than imagining lines.
Fibonacci is a sequence or rule of numbers where the number is the sum of the two previous values.
EXAMPLE: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and will go on infinitely
The Fibonacci sequence also creates the pattern and the Golden Ratio, which is calculated by dividing the Fibonacci numbers by their previous value. The pattern symbolizes many structures in nature, like the flower pedals, galaxies, and much more.
The person who created the Fibonacci sequence was Leonardo Bonacci, also known as Fibonacci. He was an Italian mathematician from the Republic of Pisa.
For more information on the Golden ratio, visit here
Fibonacci Retracement Levels
Fibonacci retracement levels are levels that come from the numbers of the Fibonacci sequence. On the trading floor, they are used as horizontal lines, which are usually used to catch retracements, and as supports and resistances.
The ratios of the Fibonacci sequence are then used to determine different price levels compared to low to high or high to low.
Each retracement level is associated with a Fibonacci percentage. The example shown above has various different Fibonacci levels.
The most usual or default values are:
- 0%
- 23.60%
- 36.20%
- 50% (NOT AN OFFICIAL FIB LEVEL BUT IS STILL POPULARLY USED)
- 61.80%
- 76.40%
- 100%
Unlike many other indicators, like Bollinger bands, moving averages, pivots, etc., the Fibonacci Retracement tool will not update with new market data, unless you program a custom Fibonacci plotter. It will have to be manually updated to whatever high and low you want.
TRENDS AND FIBS
OTHER USES OF THE FIBONACCI RETRACEMENT
The Fibonacci Retracement can also be used for other things. The Elliot Wave Theory uses Fibonacci Retracement to find retracements once the reversal of the waves happen.
On this basic Elliott wave, you can see that each retracement is around the zone of 61.80% and 50% levels. This is a popular level that many users of the Elliott Wave use for the retracements
We have already gone over Fibonacci retracements; the other Fibonacci tool is the Fibonacci extension. Instead of trying to catch retracement levels, the Fibonacci Extension will instead attempt to determine take-profit levels in a trend. On most platforms like TradingView and MetaTrader, you can set custom levels, and each comes with its own rules.
The most popular level for the Fibonacci Extension is the 161.80% level, also one of the most common Golden Ratio numbers.
Traders can use Fibonacci extensions to see where their long-term positions will go, but it can be used at any timeframe. It is also used many times in Elliott Waves to see potential price moves.
In my opinion, Fibonacci Extensions are terrible and inconvenient tools; there is no guarantee they will hit the target prices, and you should not use them for entries. You could use this for one side, but before you enter, you should use other indicators as confirmations. The price could reach or not reach the target price.
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