Fibonacci: The Fundamentals

Applying Nature's Harmony to Financial Markets

From flower petals to far away galaxies, the Fibonacci pattern is found across the natural world.

Fibonacci patterns are derived from the Fibonacci number sequence where each number is the sum of the two preceding ones: 0, 1, 1, 2, 3, 5, 8, 13, and so forth.

Some traders believe the Fibonacci sequence and its derived ratios, like 38.2%, 50% and 61.8% occur in the price movements of financial markets. These ratios are used to predict levels at which assets might retrace or extend their trends.

I. Fibonacci Retracements: Add Precision When Timing Pullbacks

Fibonacci retracements are based on the idea that after a significant price movement, an asset often retraces a portion of that move before continuing its original trend. The retracement is simply a pullback against the impulsive trending move.

Identifying the impulsive trending move is pivotal to drawing Fibonacci retracements. This trending move is known as the ‘impulse leg’ and is labelled X-A on our charts (below).

The Fibonacci retracement tool can be overlayed on top of any impulse leg to provide a series of retracement levels generated from the Fibonacci number sequence.

Fibonacci Retracement Levels:
Past performance is not a reliable indicator of future results

38.2%: This level indicates a moderate retracement. It's often seen as an area where traders might anticipate a reversal or a continuation of the trend.

50%: A key level, suggesting a potential halfway point for the retracement. Traders closely watch this level for potential shifts in market sentiment.

61.8%: Known as the "golden ratio," this level holds perhaps the most significance in the world of Fibonacci – it is the ratio described by Leonardo da Vinci as representing divinely inspired simplicity and orderliness.

78.6%: While not as commonly used as the others, some traders like the 78.6% retracement as it is perceived to offer the greatest potential reward relative to X (the inception of the trending move). However, the deeper the retracement the weaker the trend.

Fibonacci Retracements in Uptrends:
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Fibonacci Retracements in Downtrends:
Past performance is not a reliable indicator of future results

Uses of Fibonacci Retracements:

Identifying Support and Resistance:These retracement levels often act as potential areas where price movements may pause or reverse.

Planning Entry and Exit Points: You can use Fibonacci retracements to plan entry points for trades during a trend and set exit points to take profits or minimise losses.

Confirmation Tool: When Fibonacci levels align with other technical indicators or chart patterns, they can provide confirmation for trade setups, adding confidence to trading decisions.

II. Fibonacci Extensions: Projecting Price Targets and Beyond

Fibonacci extensions are used to project potential future levels beyond the initial trend. They help traders anticipate where price movements might extend.

Like Fibonacci retracements, the impulse leg (labelled X-A) is key. The Fibonacci trend extension tool can be overlayed onto your impulse leg to generate Fibonacci-based levels to which the impulse leg may extend.

Common Extension Levels: Some commonly used levels are 138.2%, 161.8%, and 261.8%.

Fibonacci Extension Levels
Past performance is not a reliable indicator of future results

Fibonacci Extensions in Uptrends
Past performance is not a reliable indicator of future results

Fibonacci Extensions in Downtrends
Past performance is not a reliable indicator of future results

Uses of Fibonacci Extensions:

Setting Profit Targets: You can use extensions to establish potential price targets, aiding in setting profit-taking levels for their trades.

Predicting Price Reversals or Extensions: These extension levels can signal where a trend might exhaust or where it could extend further, assisting traders in adjusting their strategies accordingly.

While debates surround the impact of Fibonacci in markets, the core principles—identifying strong impulse legs, timing pullbacks precisely, and projecting targets—form the cornerstone of price action trading. Next week, we'll explore the synergy of retracements and extensions, delving deeper into the captivating realm of advanced Fibonacci patterns.

Disclaimer: This is for information and learning purposes only. The information provided does not constitute investment advice nor take into account the individual financial circumstances or objectives of any investor. Any information that may be provided relating to past performance is not a reliable indicator of future results or performance.

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