Fibonacci Retracements can be applied in a variety markets to identify possible support and resistance levels.
- In this article, we look at how traders that follow multiple asset classes can apply Fibonacci analysis to their charts, building on the previous article in which we investigated the topic of confluence with Fibonacci retracements.
Market analytics has a lot of strategies and indicators. There are many ways to determine what to trade and how. A trader will quickly discover that this is more a study of probabilities than prediction. Analysis is mostly confined to looking at the past to gain the most accurate picture of the future. Sometimes trends that occurred in the past may continue in the same way they did in the past. This allows traders to identify a bias that can be used to improve their strategies. However, technical analysis is primarily used to manage risk.
This topic is explored in the DailyFX Traits of Successful Traders research. The study shows that "out-guessing" the market on an ongoing and continuous basis is not always a recipe to success. Sub-optimal risk management can lead to a loss of some favorable winning percentages.
This is where support and resistance can come into play. As a risk management tool, support and resistance provide a framework for the trader to implement their strategy. Let's say, for instance, a trader is bullish on EUR/USD but is struggling with timing the trade or managing their risk. Instead of trying to chase higher prices, which is driven by FOMO (Fear Of Missing Out), the trader should wait for support to appear, then bullish positions can be explored. A trader can then make an "if-then" statement. If the market is bullish and the pair continues to build with a bullish structure, then support should hold. I will be able stay in the trade. The trade can be closed with loss mitigation in mind. Otherwise, the trader can look for a better price and continue to trade.
HOW TO IDENTIFY SUPPORT OR RESISTANCE WITH FIBONACCI
There are a plethora of ways to find support and resistance, and the mechanism for finding levels can range from extremely simple to incredibly ornate. The Fibonacci sequence numbers are a simple way to find levels. This is one of the more complicated methods. This sequence or at least a portion of it is: 1, 2, 3, 5, 13, 21, 34 and 55, 89.
Add the two previous numbers to find the next number in the sequence. This process continues until infinity. The sequence's mathematical relationships are what is most interesting. Each number is 1.618x the value of the previous number. This is known as 'Phi', also known as The Golden Ratio. It can be found all over the world, in architecture, art, and even in nature, with the ratio spirals in pine cones or the breeding cycle for rabbits.
Traders see Fibonacci's importance as a mathematical relationship within the sequence. After the initial portion, each number in the sequence is 61.8%. Thus, 34 divided by 55 equals.618, while 55/89 equals.618. This relationship will continue to hold into infinity and is key variable in Fibonacci studies of traders' charts.
This is often plotted as a 61.8% trace of a major move.
This is furthered by the fact that each number in the sequence is divided by two numbers after it. It equals 38.2%. Thus, 34 divided by89 equals.382, while 89 is divided by 233 equals the same.
This will be used to plot the Fibonacci Retracement Study, which will show 38.2% of all the moves analyzed.
You can find the 23.6% retracement by taking any number in the sequence and dividing it three places to the right. The result is 34 divided by144 equals.236. 55 divided by 233.233 is the same. This relationship will continue into infinity. We can also add another retracement level to our charts.
This creates potential support/resistance levels, based on the previous major move. The intervals shown below are at 23.6% and 38.2%, respectively.
TAKE IT A STEP FURTHER
Fibonacci can be applied to trading charts. You may have seen additional levels. These levels are subjective and not true Fibonacci levels. The chart's mid-way marker or 50%'retracement', is often a permanent fixture. It does not have any Fibonacci value and marks the midpoint in the analyzed move.
78.6 is another common level that can be of some value. This level can be added to the Fibonacci Retracement, which provides balance since there are two levels above the 50% mark and two below it. Fibonacci does play a role in the value of.786. This is because it is the square root for.618. The 78.6% Retracement is often looked at for potential reversal plays or 'deep' tracements.
HOW TO TRADE FIBONACCI SUPPORT & RESISTANCE
Fibonacci levels of retracement can be used as any other potential support/resistance mechanism: It is just potential until it starts to play. At that point, it allows traders to execute an if-then sentence. This trade may work well if support is strong. If support is not sustained, it's time to get out and find better pastures elsewhere.
Fibonacci Retracements are subjective and can be used to make matters even more complicated. Traders have the option to choose long-term major movements in order to find levels of interest for larger-picture strategies or intra-day levels for trading swings. Fibonacci can also be applied to shorter-term charts to find levels from which to base short-term themes or setups.
To apply a Fibonacci Retracement, you need to first find a major move. Then you will need to apply the indicator starting at the beginning of the move and ending at the end. Below is a Fibonacci retracement applied to GBP/USD, and focusing on the major move that was produced around Brexit. This brings the June 2016 high at 1.5006 to the October low of 1.1950 from the same year. You will notice the horizontal lines at specific intervals of 23.6, 38.2, 50, 61.8, 78.6: These Fibonacci levels are where traders can seek support or resistance as prices continue to move.