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Forex Analysis |
Daily Technical Analysis
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Fibonacci Retracement | Fibonacci Trading | Chart Indicators- ForexAbode Forex School
Last Updated (Thursday, 22 December 2011 07:31) GMT
Fibonacci in Technical Analysis:
What goes up comes down and what goes down comes up. Even in strong trends (up or down), the prices take temporary reversal or correction. It’s like taking the breathing time before moving ahead. But to what level?
Let's what are Fibonacci numbers/sequence and how these are used in technical analysis before we see what are Fibonacci retracements:
Chart 1:
Chart 2:
Fibonacci series of numbers is a series where each number is the sum of the previous two numbers. The initial numbers of the series are as follows:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, ...,
You may check the above mentioned logic in this series i.e. 1+2=3, 2+3=5, 3+5=8 etc
The important thing to consider is that it's not the numbers which are important in the series but the ratio of the numbers i.e.
21/34 = 0.618
13/34 = 0.382
8/34 = 0.236
You will see the same ratio if you take any number in the series e.g. 233 instead of 34 and the previous numbers of 233 i.e. 144, 89 and 55 instead of 34, 13 and 8 respectively.
These Fibonacci ratios can be found in nature, science, architecture, music, art. A few examples of these ratios can be found in pine cones, sunflowers, pineapples, palm trees, spider webs, snail shells, DNA molecules and millions of other things in the universe.
When applied on trading charts, Fibonacci Retracement Levels are used as support and resistance levels: 0.236 or 23.6%, 0.382 or 38.2%, 0.500 or 50.0%, 0.618 or 61.8% and so on. The most important retracement levels out of these are 38.2%, 50.0% and 61.8%.
It is argued that it was Indian mathematicians who were well aware of this series and ratios since 6th century but the western world was introduced to this series and it's occurrence in nature and life in 1202 through the book Liber Abce by Leonardo Pisano.
The common occurrence of Fibonacci ratios in the life made technical analysts explore the possibilities of these ratios to appear in the rapidly changing prices of commodities, stocks and then Forex also. If we drill deeper and logically then we can always argue that there is nothing magical in these numbers or ratios to appear in the price movement but then we need to think why the technical analysis works. most of the time it works because we want it to work or believe that it will work. Because of this a large number of traders would be taking trading positions according to the signals generated and it is those large positions which ultimately make the market to move in the direction of the high volume positions taken. In simple words if a large volumes are bought then the price would tend to go up and if some large volumes are sold then it would make the price to go down.
Fibonacci retracements are thought to be the levels to which the trending price would retrace to when there is a slowdown in the trend. These retracement levels are best in trend. Be it uptrend (bullish market) or downtrend (bearish market). Take an example of a person running fast for a long time. He is running and running. There will come a time when he or she will pause. Take a breath before resuming the run again. It's slowing down. When price is going up and up, there will be times when it comes a bit down and then go up again. These retracement levels can be used at this time of pausing during the trend as they may indicates to what level the market may go down before moving along the trend again.
When to use:
During an uptrend you see that the upward movement is slowing, catching a breath. The market, for some time, starts going sideways instead of continuing upward movement.
When during a downtrend you see that the downward movement is slowing, and the market, for some period of time, starts going sideways instead of continuing downward movement.
The above are the times that a pull back or retracement may happen. Fibonacci retracement come handy at such times as clear by above two diagrams (charts 1 and 2). We will also see more examples as we go along this article.
Why to use:
When the pull back from the current direction (upwards or downwards) happen, it would be nice to know that to what level the reversal happens before continuing the journey in the same direction.
The three important levels of Fibonacci retracement levels are 0.382 (38.2%), 0.50 (50.0%) and 0.618 (61.8%).
Please refer the following charts:
In the forex chart 3 there is an uptrend and there was a move from point A to point B. Before moving up again, there is a drop. Just see how perfectly there was a drop to exactly 38.2% level before moving up again?
The upward trend started from point "A" and some reversal started taking place from point "B"
A = 1.4458
B = 1.5900
So total upward move was B – A = approx 1442 Pips
The price dropped to 1.5359 from point "B" i.e. 1.5900 - 1.5339 = 551 pips i.e. (551/1442)*100 = 38.21%
Please do not expect the retracements to be exactly to above mentioned ratios . But you will be surprised to find that how close the retracements would be to Fibonacci retracement levels.
When there is a continuous trend (up or down), wait till a reversal in the movement starts taking place. When reversal starts, enter the market in the direction of the ongoing trend at Fibonacci retracement level. In very strong trends you may like to put orders considering small reversal i.e. at 0.382 (38.2%) level. When the momentum of the trend is not very strong then you can expect more reversal i.e. 0.50 or 0.618 (50 or 61.8%) levels or even more than these levels.
Chart 4:
In the Forex chart 4, the upward move started from point A. The move took it to point B and then there was a pullback. Please see the small green candle encircled by the yellow circle. This green candle shows that during this period the price opened between retracement 38.2% and 50.0% levels and closed also between these two levels. But during this period it went down up to point X which is 50.0% retracement level and went up to point Y. During the next period (the bigger red candle) it went further down closer to 61.8% retracement level. During the next period (the still bigger green candle) the prices went and crossed 50.0% level and then moved up. It subsequently moved higher and higher towards point “C”
The above two examples are of uptrend. The similar pull back can be seen during downtrends. When there is a downtrend, there would be pull backs to higher levels before further downward movement.
Please see the Forex chart 5 and the continued movement of the same in chart 6:
Chart 5:
Please see the continuation of the movement in the chart 6. Chart 6 highlights the retracement upwards during this downtrend shown in chart 5 above. Please note the correction to 38.2% retracement level and to some extent towards 50.0% level.
Chart 6:
Even if a trend continues there are always small correction and reversal on the way.
It’s just like that even if the runner is very strong and still full of energy; he or she would stop for taking a breath before continuing running further.
If it’s just a small breathing break, consider 38.2% as your retracement. But then you would find retracement to 50.0% quite common. In strong trends with big movement we can target 61.8% as retracement.
Fibonacci retracement and extension levels carry important information for traders as they help to identify entry and exit points during the trade. The Extension Levels are used as targets for Taking Profit and Stop Loss or Resistance and Support Level.
These retracement levels i.e. 38.2%, 50.0% and 61.8% are used as points to enter the trade when the ongoing trend still continues. Of course the best entry position would be at the lowest possible swing e.g. at .618 retracement.
The retracement can be to different levels before a U-turn: it may hit retracement level 0.382 or 38.2% and reverse back, sometimes it gets to 0.500 (50%) level, and at times it even moves further to 61.8% level before turning back.
Fibonacci Retracement:
0.382, 0.500, 0.618 or 38.2%, 50% and 61.8% are the most important levels of Fibonacci retracement. These levels are used as support and resistance levels and also as entry and exit.
Fibonacci Extension:
1.382, 1.50, 1.618 or 38.2%, 50% and 61.8% are the most important levels of Fibonacci extension. These extension levels are used as profit taking levels.
The above mentioned levels can help in identifying entry and exits by indicating support and resistance levels. Fibonacci Pivot points can also be used to find likely supports and resistance levels.
Chart 7:
chart 8:
Chart 9:
Most of the trading platforms offer the following Fibonacci analysis tools:
Retracement and Extension Levels:
Fibonacci retracements use horizontal lines to indicate levels of support or resistance. They are calculated by first locating the high and low of the chart.
Down Trend: Select Fib Retracement tool from the available technical analysis tools and join the Top and Bottom points
Up Trend: Select Fib Retracement and join the Bottom and Top Points.
The tool automatically draws dotted lines for 0.382, 0.50 and 0.618 or 38.2%, 50% and 61.8% levels.
You will also find lines being drawn beyond the Top-to-Bottom (downtrend) or Bottom-to-Top (uptrend) range. These are Fibonacci Extension levels
The Fib retracements are shown in charts 1 to 9 above and chart 10 below.
Chart 10:
The above mentioned retracement and extension levels are most commonly used tools in technical analysis but you may also like to check other analysis tools like Fibonacci Arcs, Fibonacci Fans and Fibonacci Time Zones.
We explained Fibonacci analysis in the context of forex trading but the same stands good for stock trading or any commodity trading.
You may also use Fibonacci Pivot Point Calculator to calculate Fib pivot points and support and resistance levels.
Check our daily updated Fibonacci support and resistance levels in Forex analysis page.
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