Fibonacci Retracements

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fibonacci retracements chart

Fibonacci Trading describes the use of Fibonacci retracements and extensions, a fantastic way to gather accurate data on crucial resistance and support lines.

Since their introduction into the world of trading, Fibonacci retracements and extensions have proven to be immensely dependable and reliable and this is why they are often deemed priceless by traders.

However laying the retracements and extensions is a manual process which is ultimately at the discretion of the trader. This can lead to problems in situations when there a multiple high and low prices and laying the Fibonacci analysis on top of a candlestick chart can be inconclusive.

In these situations traders can become confused and feel less confident in their analysis. However by using Fibonacci clusters a trader can counteract this problem with a solution that is simple and effective.

Fibonacci Trading in Practical Application

By projecting the resistance and support lines, Fibonacci retracements and extensions provide invaluable data to a trader. If applied correctly the Fibonacci analysis can determine extremely accurate resistance and support lines but if applied incorrectly a trader could create problems.

Using Fibonacci analysis incorrectly is a distinct possibility when there are multiple high and low points present on a candlestick chart. In these situations it can be hard to decide which two points to choose from.

Choosing the correct two is very important because it has a big impact on where the Fibonacci analysis will detect resistance and support lines and if done inaccurately a trader might end up playing the market to false resistance and support lines.

In a situation such as this a trader can use Fibonacci clusters as a solution. Clusters are very simple to employ and although they may not provide data as accurate as a single retracement or extension they are very reliable.

The idea behind Fibonacci clusters is straight forward, a trader should lay multiple retracements and extensions over a single candlestick chart in order to determine where the resistance and support lines are. This strategy should only be employed when there are lots of high and low prices to choose from and when this is the case a trader should choose several prices and apply the Fibonacci analysis to them.

This will help determine average points of resistance and support and is much better than simply guessing two prices and using only one retracement or extension.

The result may look a bit confusing because there will be lots of information on the candlestick chart, but a trader should be able to distinguish points where several retracements or extensions line up and agree on a point of resistance or support.

If this is the case it is very likely these clusters will behave as genuine points of resistance and support and they can be relied on by traders. When a price approaches one of these clusters it should behave as expected by either rebounding or breaking through.

Fibonacci price projections are such tools used by professional traders to consistently beat the market with healthy returns on capital. Many novice and intermediate traders wish to utilize such tools but fail to do so either due to lack of knowledge or properly application of such tools.

In this article I will attempt to shed light on the subject and provide you with simple to understand basic information on how to properly calculate and apply the Fibonacci price projections in the same fashion as professionals do.

Basic Determination:

First, It is important to understand that there are two types of Fibonacci price projections and those are Internal projections and External projections.

Internal projections encompass Fibonacci retracement. Fibonacci retracement occurs when price retraces a previous trend by a certain ratio of the range of that trend. The most observed ratios are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. Because the price retraces (i.e. moves in the opposite direction of the) main trend, it is categorized as internal, or in other words, the price moves into the previous trends range. As price retraces into the range of the original trend, it is expect to stop at one of the levels mentioned above before reversing and continuing in the original direction of the main trend. Fibonacci retracements make excellent stop-loss levels.

External projections include Fibonacci extensions, expansions, and alternates/parallels. I shall breakdown each one of these studies separately below in a moment; however, it is important to point out commonality between the three studies for easier explanation.

All three studies have one thing in common and that is they enable the practitioner/trader to predict future price reversal levels outside of the previous trends range; therefore, external Fibonacci price projections are ideal for setting profit-targets. Furthermore, all three studies apply to trend continuation of a previous trend after a retracement has taken place.

The only difference between the three studies is how they are calculated and the Fibonacci ratios used in each one.

Fibonacci extensions are calculated based on the range of the previous trend after a retracement had occurred. The range of the previous trend is determined and then certain Fibonacci ratios are applied. The most observed ratios are 100%, 138.2%, 161.8%, and 200%. The resultant values are then added (or subtracted depending on the orientation of the trend) to the most extreme point previous to the retracement to determine the future price levels.

Fibonacci expansions are calculated based on the range of the retracement move that occurred after the trend. That range is determined by subtracting the two extreme points or swings that flank the price move then certain Fibonacci ratios are applied to it. The most observed ratios are 100%, 138.2%, 161.8%, 200%, and 261.8%. The resultant values are then added (or subtracted depending on the orientation of the trend) to the most extreme point previous to the most extreme pivot prior to the retracement taking place to determine the future price levels.

Fibonacci alternates, or also known as parallels, are calculated based on the range of the previous trend that occurred prior to a retracement. The range of the previous trend is determined and then certain Fibonacci ratios are applied. The most observed ratios are 138.2%, 161.8%, and 200%. The resultant values are then added (or subtracted, depending on orientation of trend) to the pivot marking the reversal of the retracement and the resumption of the original trend.

Application:

Naturally, by calculating Fibonacci projections in the fashion outlined above, the trader would have produced several price levels, all of which are of high probability to act as future price reversal areas. But, the power of this tool does not end there.

The trader can make this tool even more powerful by using the synergy among the various Fibonacci projections.

To do so, the trader would need to calculate all four Fibonacci price projections on two or three degrees of market swings. A degree means one level higher, or one time-frame higher from the degree or time-frame being observed. Therefore, 2-3 degrees higher market swings means, 2-3 higher time-frames. This is important in order to capture the various trends available in the market (long, intermediate, and short).

Once all Fibonacci price projections are determined, the trader needs to look for areas where different projected price levels cluster. This will be evident in the way the price levels overlap in a very small price range. These clusters, or confluence, of price projections act as very high probable reversal market points; more so than that each level by itself.

Naturally, this method creates multiple support and resistance levels that the trader can anticipate price reversal at and capitalize on this information to make trade decisions. Furthermore, knowing this information enables the practitioner to anticipate market reversal points in advance thus entering the market at an ideal entry price.