Written by Caught an interest in the Fibonacci strategy? If so, keep reading to learn more about it! Well, basically, the Fibonacci strategy in trading is a great tool that helps traders and investors predict where the price of an asset might reverse.
And if you’ve ever been into gambling games, you might have heard about the Fibonacci strategy. This strategy is based on the Fibonacci sequence, a series of numbers where each number is the sum of the two before it.
The sequence was discovered by Leonardo Fibonacci (as per its name) in the 13th century and leads to certain ratios—23.6%, 38.2%, 50%, 61.8%, and 78.6%—that are often seen in nature, art, architecture, and financial markets.
In trading, these ratios are used to find possible levels of support and resistance. Knowing how to use the Fibonacci strategy can improve your trading, making it a key part of any trader’s toolkit. So to get you started, below is everything you need to know about this strategy:
Understanding the Fibonacci Sequence and Ratios
It’s important to fully grasp the Fibonacci sequence and its related ratios before delving into the trading method. 0 and 1 start the series, and every number after that is the total of the two numbers before it (e.g., 0, 1, 1, 2, 3, 5, 8, 13, and so on). From this sequence, the important Fibonacci ratios in trading are derived:
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23.6% is the result of dividing a sequence number by the number three places to the right.
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38.2%: Found by dividing each number in the series by the number two places to the right of the original number.
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50%: This level is frequently employed because of its relevance in market psychology, even though it is not a Fibonacci number.
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61.8%: Also referred to as the “Golden Ratio,” this value is obtained by dividing each next number by the number that comes right after it.
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78.6%: This is the square root of 61.8% and offers yet another crucial level of retracement.
Fibonacci retracement levels, which help traders predict when a market correction could end and the original trend may restart, are calculated using these ratios.
How the Fibonacci Retracement Level in Trade is Applied
Finding a notable swing high and swing low on a chart is the first step in using the Fibonacci retracement tool. The retracement levels run starting from the high to the low in a downtrend and from the low to the high in an upswing. The resulting horizontal lines show possible levels of support or resistance where the price might stall or reverse.
How Combining Fibonacci Retracements with Other Indicators Work
Fibonacci retracement levels are strong when paired with other technical indicators, even though they can be strong on their own. As an example:
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Moving Averages: A Fibonacci level’s importance as a possible support or resistance zone is strengthened if it coincides with a moving average.
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Trendlines: An extra indication of a possible reversal is provided when a Fibonacci level and a trendline align.
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Oscillators: By confirming whether an asset is overbought or oversold at a Fibonacci level, oscillators like as the Moving Average Convergence Divergence (MACD) and Relative Strength Index (RSI) can increase the likelihood of a profitable transaction.
Fibonacci retracement combined with various indicators offers a more thorough analysis that assists traders in sifting through erroneous signals and arriving at more educated judgements.
How Fibonacci Extensions for Profit Targets Work
Fibonacci extensions are another tool used to pinpoint possible profit targets in addition to retracement levels. Extensions assist traders in predicting where the price may go after the retracement is finished, whilst retracement levels are used to forecast where the price may draw back. Fibonacci extension levels, which are drawn over the 100% mark and represent possible regions of resistance or trend reversal, are 161.8%, 261.8%, and 423.6%.
Risk Management with Fibonacci Levels
Any trading method, including Fibonacci retracement, must have a strong risk management plan. Stop-loss orders are a useful tool for traders to safeguard their capital in the event that the market swings against their position.
Setting a stop loss just above the subsequent Fibonacci level or the swing high or low is a standard strategy. In this manner, possible losses are limited because the trader is instantly removed from the transaction if the market breaks over the Fibonacci level.
Take away
So whether you’re wondering how to trade shares, stocks, forex, crypto and so on, more efficiently with the use of the Fibonacci strategy, you can start by learning everything you can about it!
Having a good understanding of this strategy can help you make better trading decisions and predict market movements more accurately.
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