Fibonacci Ratios and Methods in Technical Analysis
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One of the most interesting branches of technical analysis is Fibonacci Ratios. The basic logic in Fibonacci method is that the mathematical structure seen in the order of nature is also valid in financial markets. For a better understanding of this mathematical structure, lets first look at Leonardo Fibonacci and fibonacci numbers:
Leonardo Fibonacci, was born in Pisa, Italy in 1170. He spent his childhood in North Africa due to his father’s customs duties. He studied mathematics in the Islamic world, which was far more advanced than Europe in mathematics at that time.
In 1200, he returned to Pisa. In Pisa, he wrote his famous work “Liber Abaci”, meaning “The book of Calculation”. This work led western mathematicians to discover Arabic numerals and decimal numbers.
Fibonacci, with his studies aimed at revealing the mathematical structure of nature, pioneered developments that could be considered as a revolution in the world of science and art in the post-death period.
Fibonacci Numbers
For all theories Fibonacci put forward, the sequence of numbers is the cornerstone. The first number in the sequence is 0. In the sequence of numbers, the numbers are obtained by adding the previous number:
0+1=1, 1+1=2, 1+2=3, 3+2=5…
The Fibonacci number sequence obtained after the calculation is as follows:
Fibonacci sequence has interesting features:
- In the sequence, each fourth number can be divided by 2, every fifth number can be divided by 5 and every eigth number can be divided by 8.
- Multiplying any number in the Fibonacci number sequence by 1,618 (Golden Ratio) gives the next number approximately. As the numbers grow, the approximation rate increases.
- 0.618 times the number of any given number gives the previous number approximately. As the number increases, the approach ratio increases.
- 2,618 times any number, two rows give the next number.
- 0.382 times any number, two rows give the previous number.
- Except for 1 and 2, all fibonacci numbers times four plus another Fibonacci number gives another Fibonacci number:
3 x 4 = 12 + 1 = 13, 5 x 4 = 20 + 1 = 21, 8 x 4 = 32 + 2 = 34…
The Golden Ratio
The Golden Ratio is a special ratio found in the form and structure of many living and inanimate beings in nature. It is possible to see the golden ratio together with the Fibonacci number sequence.
The golden ratio known in ancient Egypt and Greek civilization was introduced into the mathematical literature by Fibonacci. This ratio was used by many artists and scientists, especially Leonardo Da Vinci.
The famous German astronomer Johannes Kepler highlighted the importance of the golden ratio as follows:
“Geometry has two great treasures; one is the Theorem of Phytagoras; the other, the division of a line into extreme and mean ratio. The first we may compare to a measure of gold; the second we may name a precious jewel.” — Johannes Kepler
The golden ratio is an irrational number. It is written in the decimal system as 1.618033988749894 … but it is accepted as 1.6180 in the calculations.
In Fibonacci number sequences, the relationship between the coefficient of 0.618 obtained by division of the small number to the large number and the number of 1,618 obtained by dividing the large number by the small number gives the fibonacci ratios:
- 0,618÷1,618 = 0,382
- 1÷1,618 = 0,618
- 0,618 x 1,618 = 1
- 1 x 1,618 = 1,618
- 1,618 x 1,618 = 2,618
- 2,618 x 1,618 = 4,236
- 4,236 x 1,618 = 6,853
Fibonacci Ratios in Technical Analysis
0.382, 0.500 and 0.618 ratios are used frequently in technical analysis. These ratios are used in the rise and correction movements.
Fibonacci Ratio methods is mainly used to determine the medium and long term support and resistance. However, it is also used to determine the support and resistance of short-term movements.
There are three ways to use Fibonacci Ratios in Technical Analysis:
- Fibonacci Retracement Levels [Most Common]
- Fibonacci Time Zones
- Fibonacci Fans
1. Fibonacci Retracement Levels
Fibonacci Retracement is the most commonly used method in technical analysis. In this analysis method, Fibonacci support and resistance levels are obtained with the help of the line drawn from the bottom of the trend to the peak level.
This method, which does not produce a stand-alone buy and sell signal, is particularly successful in determining medium and long-term support and resistance. This method can also be used for short term. However, the success rate is slightly lower than the medium and long term.
The basic logic of this method is that the difference between the bottom and the peak in the trends and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels.
The Fibonacci Retracement Levels and Meanings
How to draw Fibonacci Retracement?
- Focus on swing low and swing high
- Draw from significant low point
- Drag it up towards the next significant high point
- Pull the tool over to the right handside to allow price action play out
Bullish Wave
To draw Fibonnacci Retracement in bullish wave, you need to draw from low to high. As you can see the chart above, significant low is $9850, significant high is $12070.
Price bounced from 0.50 level which is medium pulback bounce level. After the bounce, price reached -0.27 first extension level.
TIP: If you are struggling to find swing high and low, you can use PivotsHL indicator.
Bearish Wave
To draw Fibonnacci Retracement in bearish wave, you need to draw from high to low. As you can see the chart above, significant low is $9850, significant high is $12070.
Price rejected from 0.382 level which is fast and aggresive pulback retracement level. After the rejection, price reached -0.27, -0.618 extension levels. This is perfect strong downtrend example.
TIP: If you are struggling to find swing high and low, you can use PivotsHL indicator.
REMEMBER: The market can move up and down in a very fast paced manner. Always plot your support and resistance levels.
2. Fibonacci Time Zones
Price is not the only variable in technical analysis. The time variable is also an important subject of investigation. For this reason, Fibonacci theories are used in price movements as well as in time intervals.
Fibonacci time intervals consist of vertical lines drawn from the bottom or top with the help of Fibonacci numbers.
At the drawing stage, the bottom or the peak is accepted as 0. Then, the lines of the time intervals created using the Fibonacci numbers are placed on the price graph.
According to the basic logic used in using Fibonacci numbers in this method, each Fibonacci number represents the number of days in the time interval.
The first Fibonacci number 1 represents a one-day time interval, the second Fibonacci number 2, a two-day time interval, and the fifth Fibonacci number 8, which represents the eight-day time interval:5, 8, 13, 21 and 34 days are drawn to hit the period.
According to the basic logic of this method, important movements occur at each time interval. Fibonacci time intervals, do not give buy or sell signals and are mainly used to determine the duration of fluctuations.
3. Fibonacci Fans
Fibonacci ratios can be seen in Fibonacci Fans. As in other Fibonacci analysis methods, the Fibonacci fans first draw a reference line between the bottom and the peak.
However, the reference line drawn in this method should be drawn to the peak of the intermediate trend.
Fibonacci Fans are used to identify significant support and resistance levels in emerging trends.
Rising above the 38.2 line in rising trends means an excessive rise and a correction for the medium term can be expected.
It is interpreted that the sagging below the 61.8 line has fallen too much. However, failure to strengthen buyers at these levels may mean trend reversal. Indicators are generally used at this point.
IMPORTANT: Fibonacci Fans are a method of analysis whose reliability is questioned. It does not work properly during periods of hard movements. Therefore, it is recommended to use in markets where volatility is lower.
Personal Opinion
I trade for a very long time in cryptocurrency and commodity market. Fibonacci ratios plays big role in technicals. Most of the indicators and trading bots use Fibonacci Ratios. I think people should understand the beauty of the Golden Ratio and Fib Ratio.
Personally, I do not use Fibonacci retracement in cryptocurrency market. I only use the Fibonacci Ratios in moving averages. They work perfect because when the market is volatile, we need dynamic support/resistance levels not just static lines.
Also, support your bias with other technical analysis methods and fundamental analysis. Try to learn how to trade in your way. Because if you learn, you will earn…
I hope this reading will help you to understand “Fibonacci Ratios and Methods in Technical Analysis”. Do not forget to read “Trading The Ichimoku Cloud”. Thank you…
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