Day traders and investors use many tools to decide whether to buy or sell financial assets such as stocks, commodities, cryptocurrencies, and forex. They use technical indicators and other specific tools to determine their entry and exit points.
In this article, we’ll look at the Fibonacci Retracement indicator and how to use it in the market, while also getting into the top strategies where this tool can be a game-changer.
What is the Fibonacci sequence?
The concept of the Fibonacci retracement tool is based on Fibonacci sequence. For the uninitiated, the Fibonacci sequence was discovered many years ago to explain a series of how numbers follow one another.
The sequence works by adding the two numbers before it. The first number in this case is 0 while the next number is 1, followed by 1. So, in this case, the first few numbers of the sequence are:
In this case, the next number in this series is 13 (8 + 5) while the next number is 21 (13 + 8).
So, the Fibonacci sequence rule is:
In this case, Xn is the number “n” while Xn-1 is the preceding term (n-1) while Xn-2 is the number before that (n-2). A good example of this is term 9, which is calculated as follows:
| Xn = X9-1 + X9-2 |
| = x8 + x7 |
| = 21 + 13 = 34 |
What is a Fibonacci retracement?
Fibonacci retracement is a tool that uses the same principles as the Fibonacci sequence. In this case, this tool uses several numbers in the sequence.
The major Fibonacci sequence numbers in the sequence are 23.6%, 38.2%, 61.8%, 78.6%, and 100%. while the 50% figure They are placed in the patch, and the number is usually included in Show the neutral point.
Fibonacci retracement tool not an indicator. Instead, she is athletic a tool Used by traders and investors To identify potential support and resistance levels.
It is also used to identify potential areas of drawdown and continuation. The chart below shows the Fibonacci retracement tool applied to a Tesla chart.
Fibonacci extension
The most popular tool for this is known as the Fibonacci retracement. but, Many people still use it Another tool known as Fibonacci extension.
The extension is used To predict the next key levels To watch if the price moves above the upper or lower sides of the underlying instrument in the future. Span numbers are usually 1.61, 1.50, 1.38, and 1.23 among others.
Why do we use Fibonacci retracement?
There are several reasons why traders and investors use Fibonacci retracements. Here are the top reasons why these people use Fibonacci retracement tools.
To identify support and resistance
The most common reason people use Fibonacci retracements is to identify support and resistance levels. supports known as a region Where the price is struggling to move down. It is often seen as the floor of assets.
On the other side, resistance known as a roof Where an asset is struggling to move above. As such, it is often seen as a roof.
These are the two most important levels a trader uses to operate the markets. In the chart below, we can see that the stock found a strong resistance at ~$257, which is the 50% Fibonacci retracement level.
To identify potential breach areas
The other method is to use the tool to Identify breaches. A breakout is the price at which an asset suddenly rises or falls out of a range.
In the example above, the upside breakout would be confirmed if the price moved above the 50% retracement level. If this happens, it means that the price will likely continue to rise as buyers target the 61.8% retracement level at $295.
To set the levels of stop loss and take profit
The next major reason traders use the Fibonacci retracement tool is to set stop loss and take profit. In most periods, traders place stop-loss and take-profit orders slightly above or below key retracement levels.
Fibonacci retracement strategies
After we have seen the best uses of the Fibonacci retracement tool, let’s go ahead and check out the strategies in which it can be used.
Using Fibonacci retracement to follow the trend
Trend tracking is a trading strategy that a trader aims to achieve Buying and holding assets as their price continues to rise. In the same period, it involves default and hold Origin as it continues to descend.
In following the trend, the Fibonacci retracement can help you identify pullbacks Where you should buy the dip and vice versa.
A good example of this is shown below. As you can see, CAC 40 rises when it retraces to 6824 (38.2% Fibonacci retracement) and then resumes the uptrend.
Using Fibonacci to trade reversals
Reversal is an important concept in trend following. It occurs when an existing trend fades and then a new one begins. In most periods, all trends usually end in a reversal. Traders use several tools to learn how to identify reversal points.
For example, they use a moving average crossover like the golden cross to identify these reversals. They also use a Fibonacci retracement tool. For example, in the chart below, we see that the CAC has made a bullish cross. The bullish breakout was confirmed when the price moved above the 50% Fibonacci retracement level at 6612.
Place a stop loss and take profit
The other way to use the Fibonacci retracement tool is to place a stop loss and take profit. In the example below, suppose you bought the CAC 40 at the 50% retracement level at 6,612.
In this case, you can place the take profit at the 61.8% retracement point at 6800 and the stop loss at 6400. If the trade works well, the take profit will be triggered at 6833 while the stop loss will be triggered at 6378 if the trade fails.
Using Fibonacci retracement of psychological levels
Another approach to using the Fibonacci retracement is to identify the psychological levels at the origin. A psychological level is the price at which an asset behaves in a unique way. In most cases, the most psychological levels are even numbers like 100, 20, and 30. In many cases, traders use these Fibonacci retracement levels as psychological points.
Combine Fibonacci and other tools
The fact of the Fibonacci retracement is that it is almost impossible to use on its own. Therefore, traders use it in combination with other tools. The most common tools that traders use when using the tool are indicators such as the moving average, the relative strength index (RSI), and the MACD.
Traders also use many techniques such as head and shoulders candlestick patterns and rising wedge patterns to predict the next moves in an asset. Moreover, traders are also integrating it with tools like Andrews Pitchfork. Jan Fan, and Vape circuits among others.
summary
Fibonacci retracement is an important tool that allows traders to identify key support and resistance levels. It also serves many roles in the financial market such as setting stop-loss and take-profit levels and psychological points.