What are Fibonacci Numbers and what is Fibonacci Trading?
Leonardo Fibonacci introduced the Fibonacci numbers to Western mathematics in a 13th century book.
0, 1, 1, 2, 3, 5, 8, 13, 34, 55, 89, 144, … Each number is the sum of the two numbers preceding it. Fibonacci numbers have unique properties and a special connection to the Golden Ratio.
How I Trade with Fibonacci
Fibonacci in Trading
The magic of Fibonacci numbers is found in nature and biology. Designers, architects, and even computer scientists apply Fibonacci sequence in their work. Thus it is not surprising that traders decided to give Fibonacci a chance. However, instead of using the Fibonacci numbers directly, traders focused on the Fibonacci ratios.
34/55 = 0.618 (Divide by next number)
34/89 = 0.382 (Divide by the next next number)
34/144 = 0.236 (Divide by the next next next number)
From these ratios, we get a whole host of Fibonacci trading techniques. These techniques have grown in application and complexity. Certainly, it is possible to build a trading strategy completely around Fibonacci trading techniques.
Fibonacci Trading Techniques
There are several Fibonacci trading techniques. However, note that all Fibonacci trading techniques:
- Predict price action, not react to it;
- Attempt to find support/resistance areas;
- Are calculated based on a selected market swing.
Key Concepts in using Fibonacci for Trading
Fibonacci numbers offer a useful framework for analyzing price action. For instance, 38.2% retracement is a shallow pullback. On the other hand, 61.8% is a deep pullback. Instead of blindly classifying pullbacks, we have a framework to help us assess pullbacks.
The Fibonacci trader needs to exercise discretion in two main aspects:
First, you need to choose the swing that serves as the basis of your Fibonacci projections. You need to decide what is a market swing and adjust the selected swing as price action unfolds. A rule of thumb is to focus on major and clear market swings. Likewise, do not clutter your charts with too many lines and curves. (A common trap for Fibonacci traders.)
Second, you must decide if the projections are effective support/resistance. As shown in the examples above, not all projected support/resistance levels work well. Certainly, looking out for reversal patterns at projected Fibonacci levels is an effective trading method.
Some popular ratios we did not include in our examples are 50% and 78.6%. Consequently, you can also consider other ratios in your projection.
For example, 50% is not a Fibonacci ratio but it works well. I find the zone between 50% and 61.8% useful for Fibonacci retracements. As for 78.6%, it is the square root of 61.8%.