## Fibonacci Retracement Levels in Day Trading

## Tool to Help Isolate When Pullbacks Could End

Moves in a trending direction are called impulses, and moves against a trend are called pullbacks. Fibonacci retracement levels highlight areas where a pullback can reverse and head back in the trending direction, making them helpful in confirming trend-trading entry points.

## Origins of Fibonacci Levels

Fibonacci levels are derived from a number series that Italian mathematician Leonardo of Pisa—also known as Fibonacci—introduced to the west during the 13th century. The sequence starts like this:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89.

Each new number is the sum of the two numbers before it. As the sequence progresses, each number is approximately 61.8% of the next number, approximately 38.2% of the following number, and approximately 23.6% of the number after that. Subtract 23.6 from 100, and the result is 76.4.

These are Fibonacci retracement levels: 76.4, 61.8, 38.2, and 23.6.

## The Relevance of the Sequence

What Fibonacci and scholars before him discovered is that this sequence is prevalent in nature in spiral shapes such as seashells, flowers, and even constellations. As a spiral grows outward, it does so at roughly the same rate as the percentages derived from the Fibonacci ratios.

Some believe these ratios extend beyond just shapes in nature and actually predict human behavior. The thinking is that people start to become uncomfortable with trends that cause changes to happen too rapidly and adjust their behavior to slow or reverse the trend.

According to this theory, if someone started out with $100 in his wallet, he would begin to slow his spending—or stop altogether—once he has spent about $61.80 and has only about $38.20 remaining.

## How to Use Fibonacci Retracement Levels

When a stock is trending very strongly in one direction, the belief is that the pullback will amount to one of the percentages included within the Fibonacci retracement levels: 23.6, 38.2, 61.8, or 76.4. Some models also include 50%.

For example, if a stock jumps from $10 to $11, the pullback should be expected to be approximately 23 cents, 38 cents, 50 cents, 62 cents, or 76 cents. Early or late in trends, when a price is still gaining or losing steam, it is more typical to see retracements of a higher percentage.

In this image, you’ll notice that between 61.8% and 38.2% there are two downward trends. This is an example of a Fibonacci retracement. The theory states that is a usual circumstance for stocks to trend in this manner because it is inherent in behavior to follow the sequence.

If your day trading strategy provides a short-sell signal in that price region, the Fibonacci level helps confirm the signal. The Fibonacci levels also point out price areas where you should be on high alert for trading opportunities.

Using a Fibonacci retracement tool is subjective. There are multiple price swings during a trading day, so not everyone will be connecting the same two points. The two points you connect may not be the two points others connect.

To compensate for this, draw retracement levels on all significant price waves, noting where there is a cluster of Fibonacci levels. This may indicate a price area of high importance.

## Retracement Warnings

While useful, Fibonacci levels will not always pinpoint exact market turning points. They provide an estimated entry area but not an exact entry point. There is no guarantee the price will stop and reverse at a particular Fibonacci level, or at any of them.

If the price retraces 100% of the last price wave, the trend may be in question. If you use the Fibonacci retracement tool on very small price moves, it may not provide much insight. The levels will be so close together that almost every price level appears important.

Fibonacci retracements provide some areas of interest to watch on pullbacks. They can act as confirmation if you get a trade signal in the area of a Fibonacci level. Play around with Fibonacci retracement levels and apply them to your charts, and incorporate them if you find they help your trading.

## Day Wave Trading With Fibonacci Retracements

Day Wave trading, or more accurately day to day wave trading, is a short term trading method I have developed utilizing Fibonacci Retracements. For those of you who don’t know Fibonacci Retracements, or FR’s, are a method of predicting and projecting potential areas of support and resistance on a chart of asset prices. The levels, or retracements, are based on the Golden Ratio and correspond to mathematical relationships found throughout nature. The ratio of your arm span to your height can be expressed in this manner the same way as the spiraling pattern of seeds in the head of a sunflower. FR’s have been used as a trading tool for decades if not longer and can be one of a traders best friends if used correctly. What do I mean by correctly? I mean that you must use the Fibonacci tool as a projection of areas where signals are likely to occur, not a place where signals will occur or worse yet, treating the retracement levels as signals themselves.

I find that this method is most useful in a range bound or sideways trending market because the asset is likely to move through the retracement levels over and over again. This method does work in a trending market as well but you must be very cautious when trading against the underlying trend. I like to use charts of 1 hour or 30 minute candlesticks, depending on the asset, the MACD histogram and the slow stochastic oscillator. Like I said before, an FR level is not a signal. When price reaches that level it does not mean buy or sell. A retracement level is a place where a good signal is likely to form, I use the MACD, stochastic and other analysis to create my actual trades. Because this method works well in range bound markets or simply assets that do not have large movements in price it is particularly good with forex and forex binary options. Currency pairs tend to trade in tighter ranges compared to stocks, commodities and stock indices.

For this method simply start with the daily chart and pick a likely asset that is trending sideways and/or ranging. I have picked the USD/CHF because it has been moving in a range between 0.87 and 0.90 for about four months. The pair has just hit resistance at the upper end of the range and is now a really good candidate to make a move back to the bottom of the range making period stops at or near FR levels. On this chart you can see how the asset makes a series of movements up and down in between the two extremes of the range. These movements tend to have peaks and troughs that are the “day waves”. You can see that the pair trended up to the top of the range from May to June and then at the extreme right of the chart has confirmed resistance at the top of the range. This is a sign that the asset is going to retrace at least a portion of the range, if not the entire range. Now is a good time to use a Fibonacci to project some levels at which we may find a signal. In order to find signals day traders can now move down to a shorter term chart.

Let’s take a look at the chart below. I have now moved down to a chart of 30 minute candles in order to look for day trading signals. Notice how the pair opens at or just above the 38.2% retracement. This is a good place to start looking for signals or at least signals for signals. In fact, the opening is in itself a potentially good signal simply because we can see that the pair found support in the previous session at the retracment level. Any time the pair is near this level, until it shows sign of breaking through, will be a good entry in this example.

Soon after the open the asset makes two bullish signals that indicate the pair is likely to move back up to retest resistance which we could expect to occur around the 23.6% level. These first signals are the toughest to catch and trade on but once you establish support or resistance at one of the FR’s you can move on from there with confidence. The original confirmation of resistance occurred on the 6 th , over the next 2 days several weaker signals appear. Longer term traders could use end of day or end of tomorrow expiry to catch these. Then late on the 8 th a series of really nice signals start to show up. Notice how the pair make a nice bullish continuation pattern exactly across the 23.6% line. Remember, these lines are not going to be exact like this all the time but is uncanny how accurate they can be.

## How To Trade With Fibonacci Numbers

## What are Fibonacci numbers?

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.

Now, I will hand over to mathematician Arthur Benjamin, who is far more qualified to explain the magic of Fibonacci numbers.

## 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.

It is not surprising that, somewhere down the road, 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 got a whole host of Fibonacci trading techniques. These techniques have grown in application and complexity. And it is definitely possible to build a trading strategy completely around Fibonacci trading techniques.

## Fibonacci Trading Techniques

There are several Fibonacci trading techniques. However, all Fibonacci trading techniques:

- Anticipate price action, and not react to it;
- Attempt to find support/resistance areas;
- Are calculated based on a selected market swing.

The predictive nature of Fibonacci trading tools draws traders who are sick of lagging indicators.

For clarity, we applied the different Fibonacci tools below on the same bull swing from a weekly chart of SPY.

### Fibonacci Retracements

This trading technique uses Fibonacci ratios to project price levels where we expect retracements to end.

Choose a market swing so that you can plot the retracement levels. The chosen market swing will define the range as shown in blue. Then, we apply the Fibonacci ratios within that range as shown by the black dotted lines.

In this example, price found some support at the 23.6% level but punched right through the 38.2% level. However, the golden ratio level (61.8%) provided solid support and stopped the retracement.

### Fibonacci Fans

From Fibonacci retracements, we are able to draw Fibonacci fans which are a series of trend lines starting from the same point.

This is the same chart as above. We added the Fibonacci fans in red.

Draw a vertical line down from the peak of the chosen swing. Then, draw a trend line that passes through the lowest point of the swing, and the point where the vertical line and a retracement level intersect. There are three retracement levels, so there are three trend lines.

For down swings, apply the same logic.

These trend lines act as support and resistance as circled in black.

### Fibonacci Extensions

This trading technique is similar Fibonacci retracement. However, instead of projecting retracements within the range of the swing, it projects extensions beyond the swing and is useful for planning price targets.

We used the same chart as earlier examples but included more price action to the right of the chart. The black extension lines are possible resistance levels.

The 23.6% level was a decent conservative target. There was also a minor resistance at the 100% extension level. Some of the extension levels acted as support which demonstrates the flipping of resistance to support.

### Fibonacci Circles & Arcs

Apparently, straight lines are not enough. Let’s bring market geometry to another level. Come on, bring the circles in.

These circles add a time element to Fibonacci trading. The curves are reminiscent of parabolic chart patterns and the Parabolic SAR trading indicator, which come from the concept of accelerating prices.

The top of the swing acts as the center of the circle. Draw a circle using the swing as the diameter and you get the 100% circle level. Then, use Fibonacci ratios to calculate different diameters for the other circle levels.

Circle trading uses entire circles as potential support and resistance level while arc trading uses only the bottom half of the circles (below the red line). As you can see from the example above, the 61.8% circle level was a great support for price. The other levels are less impressive.

### Fibonacci Time Extensions

Apply Fibonacci extensions to the horizontal time axis and you get Fibonacci time extensions. The extension lines mark out when we can expect the market to turn.

In this example, the 138.2% and 200% extensions caught the turning points.

Since these are time extensions, do not use this trading technique on charts without a time base.

Another Fibonacci trading technique that uses time is the Fibonacci time zones. It projects time extensions using Fibonacci numbers instead of Fibonacci ratios. From the chosen point, it extends 1 bar to the right followed by 2 bars, then 3 bars. Then, another 5 bars followed by 8 bars and so on. You get the idea.

## How to Really Trade with Fibonacci Numbers

Fibonacci numbers are near magical in nature and biology, and are wonderful in design and arts. We might find part of that magic and wonder in financial markets driven by human psychology.

At least some academics agree with the power of Fibonacci numbers in financial markets.

However, Fibonacci trading techniques, like any other trading method, are fallible. **Do not attach mystical power to it.**

Regardless of whether Fibonacci numbers are magical, they offer a **useful framework for analyzing price action**. For example, 38.2% retracement is a shallow pullback and 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, we need to choose the swing that serves as the basis of our Fibonacci projections. We 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. Do not clutter your charts with too many lines and curves. (A common trap for Fibonacci traders.)

Second, we must decide if the projections are effective support/resistance. As shown in the examples above, not all projected support/resistance levels work well. Looking out for reversal patterns at projected Fibonacci levels is an effective trading method.

You can also consider other ratios in your projection. Some popular ratios we did not include in our examples are 50% and 78.6%. 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%.