Fibonacci retracement and extension levels are popular tools used in technical analysis to identify potential support and resistance levels in financial markets. They are based on the Fibonacci sequence, a mathematical series where each number is the sum of the two preceding ones.
Step 1: Understanding the Fibonacci Sequence
The Fibonacci sequence is: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ...
The key Fibonacci ratios used in trading are derived from this sequence:
Determine the overall trend direction (uptrend or downtrend).
In an uptrend, you'll draw the Fibonacci retracement from the swing low to the swing high.
Uptrend
In a downtrend, you'll draw the retracement from the swing highto the swing low.
Downtrend
2. Drawing the Retracement Levels:
Select a significant high and low on the chart.
For an uptrend:
Place the Fibonacci retracement tool at the swing low and drag it to the swing high.
For a downtrend:
Place the tool at the swing high and drag it to the swing low.
3. Interpreting the Levels:
The retracement levels (23.6%, 38.2%, 50%, 61.8%, 78.6%) indicate potential support (uptrend) or resistance (downtrend) levels where the price might reverse.
Step 3: Fibonacci Extensions
1. Identify the Swing Points:
Identify three points: the swing low, swing high, and a retracement point.
2. Drawing the Extension Levels:
For an uptrend:
Start from the swing low to swing high, and then to the retracement point.
For a downtrend:
Start from the swing high to swing low, and then to the retracement point.
3. Interpreting the Levels:
The extension levels (127.2%, 161.8%, 200%, 261.8%, 423.6%) indicate potential levels where the price could extend after breaking the previous high or low.
Fibonacci Extensions
Step 4: Using Fibonacci Retracement and Extensions for Trading
1. Combining with Other Indicators:
Use Fibonacci levels in conjunction with other technical indicators (e.g., moving averages, RSI, MACD) to confirm signals.
2. Entry Points:
In an uptrend, look for buy signals near the Fibonacci retracement levels (e.g., 38.2%, 50%, 61.8%).
In a downtrend, look for sell signals near the retracement levels.
3. Exit Points:
Use Fibonacci extensions to set profit targets. For example, if the price retraces to the 61.8% level and resumes the trend, set the target at the 127.2% or 161.8% extension level.
4. Risk Management:
Place stop-loss orders just beyond the next Fibonacci level to minimize losses. For example, if you enter at the 61.8% retracement, place a stop-loss just below the 78.6% level.
