How to use Fibonacci retracements and extensions in your trading
Fibonacci retracements and extensions are a popular tool among technical traders that help identify potential support and resistance points in the market, as in the negotiation of Stock Exchange, FOREX, etc.
But first of all, what is a Fibonacci sequence?
The Fibonacci sequence is a series of mathematical numbers that starts with 0 and 1 and then each subsequent number is the sum of the previous two numbers. The sequence is widely known in mathematics, but it is also applied in financial markets to help identify patterns and predict potential support and resistance points.
From there, the concepts of retraction and extension arise, which we talk about below.
What are Fibonacci Retracements and Extensions
Fibonacci retracements and extensions are a technical chart analysis tool that helps identify potential support and resistance points in a price movement.
They are based on the Fibonacci sequence and are plotted by drawing lines from the highest or lowest point of a relevant price movement through points where the price can retract by specific percentages.
Fibonacci retracements are based on the following percentages: 0%, 23.6%, 38.2%, 50%, 61.8% and 100%. And the extensions are based on: 61.8%, 100%, 161.8%, 261.8% and 423.6%. These percentages are used to identify points where price might stop moving and then reverse direction or continue following the previous trend.
Technical traders use Fibonacci retracements to help determine entry and exit points in trades, especially when the market is trending. And Fibonacci extensions to help determine price target points and assess profit potential on trades.
They can also use Fibonacci retracements and extensions in conjunction with other technical indicators such as oscillators and moving averages to confirm their trading decisions. All this now takes us to the stages of these two phenomena.
Fibonacci retracement and extension steps
- Find the relevant price movement → the first step is to identify a significant price movement on the chart, such as a big move up or down
- Mark point A and B → mark the highest or lowest point of the relevant price movement as point A and the opposite point as point B.
- Calculate Fibonacci retracements → Fibonacci retracements are calculated by drawing lines from point A to B, passing through points where price retraces by specific percentages of 23.6%, 38.2%, 50%, 61.8%, and 100%. These points are considered potential support or resistance points.
- Apply Fibonacci extensions → In addition to retracements, Fibonacci extensions can also be applied. This is done by drawing lines from point B through points where the price can extend by 138.2%, 161.8% and 261.8%. These are considered potential price target points.
- Analyze support and resistance points → once you have plotted Fibonacci retracements and extensions, you can use these points as indicators to enter or exit a trading position. If the price approaches a retracement point, it could be a signal to buy or sell, depending on the direction of the price movement.
Keep in mind that Fibonacci retracements and extensions are just one tool among many used by technical traders, and should not be used as a stand-alone trading strategy.
It is important to combine retracements and extensions with other technical indicators and fundamental factors when evaluating your trading decisions. Let’s see in more detail.
What is the strongest zone of the Fibonacci strategy?
The strongest Fibonacci retracement and extension zones are widely considered to be the 38.2%, 50% and 61.8% zones. These zones are considered stronger because they occur more frequently and are more reliable compared to other percentages.
The 61.8% zone is especially important as it is considered the Fibonacci “golden ratio” and is widely used by technical traders to identify support and resistance points and to predict price target points.
- Light Retractions (23.6%) → are the most common and have a short duration. They occur quickly
- Moderate Retracements (38.2%) → are considered intermediate, as they occur when the price retreats to the 38.2% range and loses strength, returning to its original movement
- Retractions of (61.8%) → are the most intense, but less frequent, retractions. When the recoil reaches 61.8%, it reaches the “golden number” according to the theorem
Warning Zone → It is crucial to be aware of warning zones, which are points where a trader can identify potential trend changes, supports and resistances.
Final considerations
The Fibonacci strategy is a technical approach widely used in stock, FOREX, commodity and other financial markets. It relies on proportions and relationships found in the Fibonacci sequence and chart analysis to predict support, resistance and price targets.
However, it is important to remember that none of these zones guarantee trading success and that Fibonacci analysis should be used as part of a diversified and reasoned approach to trading.