Basic theory of Fibonacci levels
The sequence of Fibonacci numbers has been known since ancient times, but only in Italy in the XII century were the mathematical properties of this series formulated. In trading, the Fibonacci sequence is represented as levels located at a fixed distance from each other. These distances are obtained by dividing the main term by each subsequent one from the Fibo series.
From this overview, you will learn:
- How Fibonacci levels are calculated in trading: essence, formula, level values.
- Fibonacci retracement grid construction rules.
- Features of the indicator application.
Fibonacci levels in trading
The Fibonacci Correction Levels indicator is based on the ratio of sequence numbers to each other. The levels in this instrument are horizontal. As practice shows, with the correct construction, intermediate levels act as marks of the end of the correction, that is, those points at which a price reversal towards the main trend is most likely.
The indicator scale has extreme points of 0% and 100%. The Fibonacci grid is built from the beginning of the trend to its end, the value of 100% will be at the beginning of the trend, 0% at the end.
There are intermediate levels between them:
- 23.6 is the very first and weakest level. Correction in most cases breaks this mark. But in case of a reversal, it is safe to say that the price will continue its strong upward movement.
- 38.2 – One of the strongest correction levels, here the first correction ends most often. Further, either the continuation of the trend or price fluctuations between the levels of 38.2 and 23.6 are possible.
- 50 is an intermediate level. Its passage is the first signal that the correction is being delayed and a trend reversal may take place.
- 61.8 is a strong corrective level. The most protracted corrections unfold here.
The principle for calculating these levels is as follows.
For example, there is part of the series 13, 21, 34, 55. 13/21 = 0.618 or 61.8% (the value is approximate, but 21/34 and 32/55 also tend to it). 13/34 = 0.382 or 38.2%. Etc. Some terminals have an extra level of 78.6, which is the square root of 61.8. It is believed that its passage means the beginning of a new trend. However, there is also the Dow Theory, which states that a new trend appears when the entire length of the old one is passed, that is, the 100% mark is broken in the opposite direction.
The formula for calculating the value of the price of Fibonacci levels in trading:
- Price = X + (Y – X) * Level – for an uptrend.
- Price = X – (X – Y) * Level – for a downtrend.
X – price of the end of the level corresponding to the 0% mark, Y – price of the beginning of the trend, corresponding to the 100% point.
Meshing rule. The grid is built from the beginning of the uptrend – from its minimum. And it stretches towards the end of the trend – to its maximum. For a downtrend, the construction is mirrored: from high down to low.
The principle and essence of building Fibonacci correction levels in trading:
- On an already built trend, the grid is superimposed in order to see the most significant support and resistance levels for manual drawing on the current movement.
- On the current movement, the principle of grid construction is as follows:
- We are waiting for a trend to appear. It will be either a reversal of the old trend, confirmed by patterns and oscillators. Or exit from the flat. At the extremum, set the beginning of the indicator.
- We are waiting for the first correction. As soon as the price reverses, we put the second point at the extreme.
- As soon as the correction ends and the trend redraws the extremum, we stretch the grid to it.
Trading strategies based on Fibonacci retracement levels in trading:
- Swing trading. We are waiting for a local rollback to levels 38.2 or 50, wait for the end of the correction and open a deal on a rebound from these levels or their reverse intersection towards the main trend.
The grid is built according to the extrema of the uptrend, marked with rectangles. Trades are opened on correction – after the maximum before it was redrawn (in this case, the redrawing did not take place and the trend went down). The arrows indicate the points of opening deals – a rebound and a breakdown of the levels 61.8 and 38.2. We close trades upon reaching the nearest resistance levels along the trend.
- Reversal strategy. We are waiting for the correction to break through the level of 61.8, open a position in the direction of the new movement.
Whether Fibonacci levels work in trading or not is a rhetorical question. But a psychological pattern speaks in favor of the mathematical approach. Tell me, would you be guided by these levels if you did not know about their existence? No. But now that you know about them, you will use them, for example, to place stops or pending orders. Now imagine that most people think so. If an uptrend correction goes down, pending buy orders are located at the key level, then when they are triggered, the price will automatically go up. In other words, these are not “Fibonacci levels work”, but traders themselves make the levels work by placing orders at these levels in large quantities.
Features of working with Fibonacci levels:
- Most often, levels are plotted on a line chart. If using a candlestick, draw a grid at the ends of the shadows. However, there are no hard and fast rules. There are examples of gridding, for example, from the end of the trend to the beginning.
- It is recommended to draw a grid on the chart with an interval from M30-H1.
- An auxiliary tool, supplement it with Price Action techniques and trend indicators.
- In the foreign exchange market, corrections are more frequent and deeper. In the stock market, corrections end quickly, the trend is more stable and longer. Use this in your strategies.
If you have any questions, ask them in the comments!