Fibonacci trading sequence

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How To Use Fibonacci In Your Trading

Last updated on October 27th, 2020

When trading with Fibonacci levels (fib levels), remember they are just a tool and like any tool and any type of trading system, the usefulness depends on the user and the rules they follow in their application.

I am going to fully show you a simple way to trade with Fibonacci levels so you can start practicing your technique today.

You have probably heard that the main knock of Fibonacci levels is: “place a bunch of Fibonacci retracements and extensions on your charts and some are bound to act as support and resistance levels”.

While that may be true, there are several ways that may help you get a handle on Fibonacci retracement trading to find potential reversal points on your chart.

What Is The Fibonacci Sequence?

We can thank an Italian mathematician named Leonardo Pisano Bigollo, for bringing Fibonacci to the world.

A Fibonacci retracement is based on ratios derived from the Fibonacci sequence. The sequence is formed by adding the prior two numbers together to form the next.

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610…

As numbers go higher, the ratios of n:n-1 and n:n+1 (where n = any number in the sequence) approximate 0.618 and 1.618 respectively. This is often referred to as the Golden Ratio and it can be found, along with derivatives of it, throughout the natural world.

0.382 is 1 – 0.618 and these two numbers along with 0.5 make up what we recognize as the most common format of the Fibonacci retracement drawing tool.

Additionally, there are some derivative ratios that are frequently used. The square root of 0.618 gives us a common 0.786 value. The inverse of the square root of 0.618 gives us a common extension value of 1.272.

There are other ratios, but these are, at least in my book, the main ones.

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Using Fibonacci Retracement Levels

A retracement in trading is where the price will rally or decline to a potential support or resistance zone and using Fibonacci retracements, you can find potential levels where price will stop.

Taking a step back, ask yourself what are these levels representing? For me, they are a measure of human behavior and are a framework to understand emotional extremes.

Given how I look at the representation, I look to the overall move, the obvious swings (can be subjective) and also to pockets of consolidation.

The key to identifying where precisely to draw a Fibonacci retracement comes down to the same thing as using any drawing tool or technical indicator – they must be used to investigate something specific about the market and not purely point A to point B.

What I mean by this is that the tool is most effective when it’s applied to a move created by something. This could, for example, be a big move generated by an economic event (e.g. NFP, FOMC) or even one stemming from a change in state (e.g. a thrust as a market breaks out of balance).

My mentor when I was learning the basics of Fibonacci would also use thrust bars and gaps which show where extreme action resides.

The retracement levels I use from the Fibonacci sequence are 38.2 and 61.8 because less clutter on the chart will show you the most important variable – price.

Let’s go through a simple example using Fibonacci retracements to find resistance in a down-trending market – BTCUSD

FIBONACCI RETRACEMENT LEVELS – DOWN TREND – BITCOIN

  1. We start the Fibonacci retracement by pulling from the highest high on the Bitcoin chart
  2. Ending at number two, the levels 38.2 and 61.8 are plotted on the chart (the 38.2 has been removed for this example – the 38.2 is for the next example)
  3. Price retraces up to the 61.8% Fib level and using your entry method, you would short this market
  4. Using the extreme high again, we have a Fib pull ending at….
  5. Ending the Fib pull here, Fib levels are plotted and for this example, we remove the 61.8% level
  6. Price rallies into this zone present a double top, and then price collapses

This is a simple example of using Fibonacci retracements and you may see a confluence of other factors on this chart.

FIBONACCI CONFLUENCE

  1. This yellow arrow is highlighting a former resistance level that breaks as price puts in the highest high. Carried over to the right, this zone lines up with the Fib level
  2. This area is the support area we pulled the first Fib to and you can see, carried over the right, price stalled in the confluence zone

As I said in the beginning, the biggest knock of Fib levels is that a bunch of lines will get hit by random price action.

To use Fib levels as a framework helps you zone in on certain areas and then find supporting structure as indicated in the two charts above.

Fibonacci Confluence and Price Action

Fibonacci retracements do not need to be used as entry levels in order to be useful. Context alone can make them very useful.

However, there are times where a specific retracement may, in fact, qualify as an entry zone.

It is important to remember that these levels don’t necessarily act as red light/green light levels. A market can definitely move a few ticks beyond a fib retracement level and it still is valid.

However, there are times when if there are multiple technical factors in close proximity to a retracement price, it could, in fact, be a good area to look for an entry (context permitting).

For example, you might find that when you draw your Fib, the 38.2% retracement of a thrust higher, aligns with a trend line and the session open. In this case, if there’s been a rejection of lower prices, it may be an opportune area to lean on in looking for a long entry.

How To Use Fibonacci Expansions In Your Trading

An expansion is a measurement of the impulse leg of a move projected from the correction leg. To plot a Fibonacci expansion, you will use the Fibonacci expansion tool that requires three clicks and I use the numbers .618, 100 and 161.8% as I was taught.

We can use expansions in a number of ways but the most popular way is to find profit targets using the Fib ratios.

FIBONACCI EXPANSIONS FOR-PROFIT TARGETS – FOREX FUTURES EXAMPLE

This is the Yen futures chart and in this case, we are using the green circles starting at the left, going up, and then pulling the third click to the last green circle.

The expansions are plotted and what is interesting is the 61.8% lines up with potential resistance and in the end, price tops out at the 100% expansion level.

Using Expansion To Find Symmetry In The Market

One thing you may have seen is how price seems to move in waves not much different than the ones that came before it. In some cases, swing in price has been the exact same length in terms of price which makes symmetry something to consider.

You can measure the distance of one swing and project that swing to another swing and look for the 100% level which shows symmetrical pullbacks in price.

MARKET SYMMETRY – MEASURING SWINGS

This is the daily chart of wheat futures and the market is in an uptrend. Here is how we plot the yellow lines:

  1. First click at the swing high
  2. Lowest swing low after the swing high at one
  3. The leg price distance from 1-2 is projected from 3 which gives us the first yellow line. You would determine a trade entry in that location
  4. This is where the first measurement ended and we can also use the 3-4 leg and project from number five
  5. This high also contains that measure from 1-2 projected from five and 3-4 project from five

With the last horizontal line set, we are using the distance from two corrective swings and projecting from the highest high to give us an idea where a potential support level can be that will stop the price retrace and give us a bounce to the upside.

Just like the lines plotted by Fibonacci retracements, these zones are potential reversal points where you could look for trading entry.

100% Symmetry Breaks Can Be A Red Flag

The symmetry measures previous swings in the market and is a good read on the current volatility in terms of pullbacks.

If pullbacks are too strong or further in distance than previous pullbacks, you may determine that something has shifted in the current trend direction.

Here is an example of using symmetry to determine a shift in the dynamic of the market.

  1. This white line is projected from the number three high
  2. Current price location has retraced from the highest high to virtually the same price distance as we see at number one
  3. This begins a smaller measure, the green line, and is projected down
  4. Price has broken this level which would have been the end of a complex correction in this stock.

What we can determine in NKE is that something has shifted in the dynamic of this market. Complex corrections have broken and we have retraced the distance as the largest pullback in the near recent price action.

But the price action, the large momentum candlesticks, are hinting that something has changed in this current retrace in price.

By using the symmetry feature, we can either remove ourselves from a strong bullish stance, be prepared to exit a position, be prepared to reduce risk.

Develop Your Fibonacci Trading Strategies

Using Fibs to determine potential pivot points in the market can help you frame price action and ensure you are looking to trade at specific locations on the chart. There is nothing magical about Fibonacci ratios and they are hard to backtest given the subjectivity that can be involved.

You can design a trading strategy that takes into account:

  • Trend direction – using a moving average as an example
  • Retracements in price
  • Symmetry measures where breaks in symmetry are a red flag

What is vital is that you understand that Fibs are just measures of price movement and that markets move in a rhythm.

If the rhythm is broken (think symmetry) then something has changed in the market and you should understand what that is.
If you look for a big move that has some kind of significance, how the market reacts to Fibonacci retracement levels can give you a great idea of the energy the move really contains and whether a continuation is likely or not.

Once you figure out what’s going on relative to a strong move, it’s not too difficult to come up with a way to make money from the subsequent action.

If you don’t have a defined way of using the Fibonacci retracement tool, you’ll be likely to start measuring ranges and by doing this, you’ll lose the ability to assess how the market is reacting to the initially attempted direction.

Pullbacks are a common market mechanic and the Fibonacci series is just a measure of the pullback. What should be clear is that using Fibs alongside market structure is much better than relying on the Fib lines themselves.

What is Fibonacci Retracement

By Market Traders Institute

Step 1: Understanding the Fibonacci Sequence

As Italians named Leonardo go, Fibonacci is, at most, the second most famous (some guy named Da Vinci takes the number one spot). However, Fibonacci can do something for you that Da Vinci never could, fibonacci can make you money. Fibonacci’s fascination with numbers led him to discover the mathematical sequence that bears his name (also known as the Golden Ratio).

The Fibonacci sequence is as follows: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377… You may have seen this sequence of numbers on a test, a puzzle or in popular fiction like The DaVinci Code. But what does this sequence actually mean?

Fibonacci’s sequence says that, in a group of three numbers, the sum of the first two numbers will always equal the next number in the sequence.

1 + 1 = 2
1 + 2 = 3
2 + 3 = 5
3 + 5 = 8

You can see how the pattern works. Take whatever number the equation totals, add it to the second number in the equation and the new total will equal the next number in the sequence.

Step 2: Finding Fibonacci’s Golden Ratio & More

Now that you know how his sequence works, you can learn how to find what traders call “the golden mean” or “golden ratio”. You arrive at the golden mean by taking any number in the sequence and dividing it by the number that immediately follows it. This answer will be .61 or 61% (or thereabouts). So if we bring up our sequence again…..

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377

13 ÷ 21 and get 0.619
21 ÷ 34 and get 0.617
34 ÷ 55 and get 0.618

You can use the sequence to get other important ratios as well. These numbers are: 0.38 (dividing any number by the one two places to its right), 0.50 (the sum of three numbers divided by two), .786 (the square root of .61), 1.618 (dividing by the number that immediately precedes your number), and 1.27 (the square root of 1.618).

Step 3: Applying the Fibonacci Numbers to Your Trading

The reason why Fibonacci’s sequence is such a big deal is because it can be found all around nature. Everything from seashells and starfish, to trees and the distance between your elbow and hand all follow the patterns first discovered by Fibonacci. And there is strong evidence that patterns in the Forex follow this sequence as well.

Based on your entry point in the market, you can place lines on your chart that correspond to the numbers laid out by the various equations listed above (.61, .38, .78 etc.). It has been shown that, over time, the market’s rises and falls generally match up with Fibonacci’s lines. In theory, if you set your buy and sell points according to these patterns, you will be able to sell before the market turns down, and buy before it goes back up.

Finding the Fibonacci numbers are difficult enough, putting them on your chart is even more difficult, and fully understanding how they work is the most difficult of all. There’s no reason why you should try and understand this yourself.

Stocks For Beginners

Fibonacci sequence can be a very powerful tool or even the basis of a standalone trading strategy for investors and traders in bull or bear market and any time frame.

The Fibonacci sequence is the series of numbers 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 . introduced by mathematician Leonardo Pisano (nickname Fibonacci), born in 1170 in Italy. Fibonacci sequence starts with 1, 1 and afterwards Fibonacci numbers are constructed in a way, that every next number is the sum of the proceeding two: 2 (1+1), 3 (2+1), 5 (3+2), 8 (5+3), 13 (8+5), 21 (13+8), 34 (21+13), 55 (34+21), 89 (55+34), 144 (89+55), 233 (144+89), 377 (233+144), 610 (377+233) etc.

Beside Fibonacci sequence there are the Fibonacci ratios. By comparing the relationship between each number, and each alternate number, and even each number to the one four places to the right, we arrive at some fairly consistent ratios.

  • If you divide any number to the next higher number on the right, you always get 0.618 (34/55=0.618).
  • If you divide any number to the second higher number on the right, you always get 0.382 (34/89=0.382).
  • If you divide any number to the third higher number on the right, you always get 0.236 (34/144=0.236).
  • If you divide any number to the next lower number on the left, you always get 1.618 (55/4=1.618).
  • If you divide any number to the second lower number on the left, you always get 2.619 (89/34= 2.619).
  • If you divide any number to the third lower number on the left, you always get 4.235 (144/34= 4.235).
  • And so on.

The most important Fibonacci ratios are 0.236, 0.382, 0.618, 1.618, 2.618, 4.236, less important are 0.764, 1.382, and for good measure we include 0.50 and 1.00; 0.618 and 1.618 are often referred as golden ratios.

Since this simple series of numbers and ratios are describing the natural proportions of things in the universe, they are prevalent in nature all around us. Fibonacci numbers appear in ancient buildings, in plants, planets, molecules, the dimensions of human bodies, and of course snails. But of what use is all that to stock trader or investor?

Use Of Fibonacci Sequence In Technical Analysis

What really interests you is the application of Fibonacci sequence in the trading environment. Fibonacci analysis is part of technical analysis (chart analysis) that can be very useful tool for identifying support and resistance levels or determining profit targets for any time frame and any asset class like stocks, ETFs, futures, forex. As long as you are dealing with liquid instrument, the price of the security will “very often” retrace and advance in Fibonacci proportions almost to the penny. Let’s confirm that by analyzing some charts.

Factors To Consider Before You Begin Using Fibonacci In Trading

In real world of trading and investing you will not calculate all the Fibonacci levels and draw the lines on the chart by hand. Instead, you should get yourself a good enough technical analysis software, which will offer you precise use of Fibonacci retracement and Fibonacci extension tools. The tool you will use must be simple enough and should offer you easy changing of time frames, fast symbol changing and plotting other technical indicators on the chart.

You will soon find out that using technical analysis tool for drawing Fibonacci retracements by selecting two extreme points on a chart is very easy, but determining extreme low and high is the major problem of Fibonacci analysis. People look at charts differently and so will have their own version of where the extreme high and extreme low points should be. Therefore it is more recommended that you use Fibonacci sequence in combination with other fundamental or technical analysis tools and indicators, even though it can be also used as standalone tool on which your stock trading strategy is based.

Yeah, one more thing. It can happen that you will find a stock that is absolutely ignoring Fibonacci sequence levels; in this case this trading strategy can’t work, no matter how you like it.

How To Apply Fibonacci Sequence To Your Stock Trading Strategy

There are unlimited options of how to use Fibonacci sequence in trading or investing. I will cover one of the most wanted strategies, determining entrance and exit points together with risk management in uptrend. Similar (just the way around) strategy can be developed for downtrend. The presented strategy can be used in any time frame and with any instrument, according with your trading style and trading plan.

We have used Google stock as an example, daily chart from low in 11-21-2008 at $247.30 to high 01-04-2020 at $629.51. Google stock is in an uptrend since end of 2008. Of course if you would look at only 2020, than Google stock is in downtrend, but this is not our trading time frame. Last quote on 08-03-2020 was $490.41.

Plot Your Chart In Tradable Time Frame

Run you charting software and plot your favorite stock chart in the time frame, you usually trade. For example, if you are medium-term investor, use a daily or weekly chart for last few years. If you are swing trader, use daily chart for last 6 months and so on.

Plot Fibonacci Levels With Fibonacci Retracement Tool

Use Fibonacci retracement tool to draw the Fibonacci support and resistance lines on the chart. Click on the low candle and move your mouse to the high candle or however you software requires you to do it.

Determine The Trend

Trend is defined by your trading time frame and this is quite easy thing to do. Look at the chart, if the stock price is moving from bottom left corner to the upper right corner, than you have an uptrend. Most of the time you will be looking for stocks to be in uptrend or downtrend and react in the same direction of trend; other strategies are also possible, but let’s keep it simple at this point.

Determine The Entrance Level

Ok, so far we have a stock in an uptrend, which is in a correction lately. Perfect, that is exactly what we are looking for if we would like to enter the stock. Where should we enter? Anywhere around Fibonacci levels. The most preferred entrance point is at 61.8% retracement level, but it can be also earlier. Some Fibonacci traders enter the position at every Fibonacci level, starting slow, with small volumes at 23.6% and then adding up the volume at every next level.

In our concrete example of Google stock, we have already missed some entrance points in the retracement phase of the stock. I am not sorry for 23.6% entrance point, but I am sorry for being too late to enter Google stock at 50% retracement level. At the moment the stock is trading around 38.2% level and this could be also a good entry point. To enter the stock more confidently I will wait for the stock to pass the last high few days ago at $497.50 – I will put a stop buy order even a little bit higher, at $501 – yellow line (I want the stock to pass the psychological price at $500; just below round numbers there are often many selling limit orders and I am looking for the buyers with enough power to move the stock to the next Fibonacci level). If Google stock will go down before it will reach our entry level, no problem. Be patient, like I said, even better entry level is at 50% or 61.8% retracement level. Below 61.8% the trend is not your friend anymore and you can stop thinking of buying Google stock for a while.

Determine The Stop Level

No technical study is perfect; we warn you all the time about this fact. That is why you have to protect yourself in case you were wrong, in case the stock will go opposite direction to what you have expected. I suggest you to place the stop order just below the last low around the Fibonacci level of you entrance point. There are different methods of how much below last low you should set you stop; some use tight stops while other don’t like to get out of the trade to soon. I prefer to watch the stock chart, to tell me the story.

In our concrete example of Google stock, we have placed an stop buy order at $501, which is around 38.2% retracement from our time frame high. The last low around this level was $479.14 on 07-30-2020. If you will look at Google stock chart history, you will notice, that if the stock passes the low, it will continue to fall further (it almost never passes the low for a few pennies and then turns back up again). This is telling me that I can afford a tight stop in this case. I will use 0.5% stop below last low at $476.74 (red line).

Determine The Exit Level

The last thing to determine is profit target. Well, you have probably heard of wording “let your profits run while cutting loses”. That is why profit target is determined more as a level, where we will be more focused on what is happening with the stock, if there are any signs of trend reversal, rather than use it strictly as exit level. Generally you can expect the stock to extend the movement in the direction of the trend to the amount that is equal to the retracement of the stock in correction phase, but you should pay special attention to the stock movement at every single Fibonacci level. If there are sufficient signs of bulls losing their power and there is high possibility that trend will change, you better exit the position, otherwise let the profits run. One often used method is also to exit part of the position on every higher Fibonacci level, adding the exit volume on every higher level (just opposite to entering the position).

In our concrete example of Google stock, if 50% retracement will be confirmed as the last low in medium term uptrend, than we can expect the stock price to rise 50% above the Fibonacci high; our exit target is therefore at $818.64 (green line). But pay also close attention at 23.6% level ($538) and 0% level ($628) for any signs of trend change.

Recommended Reading – Recommended Reading – Recommended Reading – Recommended Reading

Fibonacci Sequence Trading Conclusion

That is how to use Fibonacci sequence in trading purposes. It helps you determine entrance and exit levels based on support and resistance. Using the strategy as explained above, you are totally controlling the risk, which is the most important thing. Remember, you can make money as long as you don’t lose it.

Google Case: In our concrete example of Google stock we have determined entry level at $501, stop at $476.74 and exit level at $818.64. Your risk per share is $24.26. If you have a $100,000 trading account and according to your trading plan your maximum loss per position is 1%, than you can afford to lose all together $1,000 on Google position; your position size would therefore be 41 shares (1,000/24.26). On the other side you have a great medium term profit potential of $317.64 per share, giving you reward- risk ratio of more than 13 (317.64/24.26).

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