How to use Fibonacci levels in trading?

Learn how to do Fibonacci trading using Fibonacci retracement levels and Fibonacci extensions.

The Fibonacci retracement is a technical analysis tool used to find support or resistance levels based on Fibonacci ratios. Check our guide to learn more!

Fibonacci levels are based on mathematical theory, which was developed by Italian scientist Leonardo Bonacci in the 12th century. This theory is widely used beyond exchange analysis, and the Fibonacci pattern is also found in many natural elements. There are at least 6 analysis tools that are applied to a chart according to the Fibonacci formula.

How does it work?

Leonardo Bonacci (also known as Fibonacci) — an Italian mathematician who presented the world with a unique sequence of numbers known today as the “Fibonacci sequence”: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584… (and so on until infinity).

Each number in the sequence is obtained from the sum of the previous two numbers. Each number is about 1.618 times larger than the previous one (and vice versa, the smaller number is 0.618 from the larger number starting from the fourth number of the row). This is the so-called “golden ratio”, which appears incredibly in every element of nature.

Take, for example, flowers: lilies have 3 petals, buttercups have 5, chicory flowers have 21, and chamomile flowers have 34 and so on. It is interesting that these figures correspond to the Fibonacci sequence, and even at the arrangement of the petals “takes into account” the figure 0.618 for optimal interaction of the plant with sunlight and other vital factors. The examples of the Fibonacci sequence are endless in nature.

How to locate Fibonacci levels?

In particular, a trader can calculate levels (which are most likely very important for the price of an asset) by dividing the upper and lower trend point (or reversal) by the “golden section” and other ratios in the sequence. The important ratios are:

• 0.382 — the ratio of any number in the sequence to the number located one to the right.
• 0.236 is a number obtained by dividing one of the numbers by a number located two to the right.

As you will see later, the price regularly shows dependence on these levels. This helps the trader to choose the optimal entry and exit points.

Before using this tool to determine potential support or resistance levels, a trader needs to determine the “maximum trend fluctuation” and “minimum trend fluctuation” (upper and lower correction or retracement point).

The trend maximum is a candlestick at the trend peak on any timeframe, with lower highs on the right and left. Conversely, the trend low is a candlestick at the lower trend peak of any timeframe, to the right and left of which there are higher lows.

Once you have identified these points, select the Fibonacci tool on the platform you are using and connect the minimum to the maximum. The platform will automatically generate potential support levels (Fibonacci correction levels) for you.

How to locate support and resistance with Fibonacci levels?

Each Fibonacci Correctional level is calculated by dividing the area between the trend high and trend low according to important Fibonacci sequence ratios.

On the chart above, the trend low for NEO (NEO / BTC) 0.001834/BTC was correlated to the trend high of 0.015170/BTC using the “Fibonacci Levels” tool. As you can see, the levels 0.236, 0.382, 0.5, 0.618, 0.786 acted (at least for a while) as support all the way down the asset price. If trader has used this instrument, he could assume where the price will get support before taking the next step. In this way, it was possible to determine the ideal entry or exit points.

The process of finding potential resistance levels is the same, except that this time you will connect the trend maximum to the minimum. Once again, thanks to the ratios in the Fibonacci sequence, correction levels will be built.

In the above chart, the expected resistance levels of Stellar Lumens (XLM / BTC) were obtained after connecting the maximum 0.00006335/BTC to the minimum 0.00002139/BTC. Further, as the theory claims, the price “paid attention” to these levels. Thus, the levels of 0.786, 0.618, 0.5 and 0.382 provided resistance, which allowed the trader to determine the optimal target points relative to his position for profit.

Does this tool work in trading?

It is important to remember that this tool can be useful in determining possible support and resistance levels, but like any other technical analysis tool, it does not guarantee you a positive result. To increase the probability of correctly identifying important correction levels, you should use this tool together with other indicators such as Moving Averages or Relative Strength Index (RSI).

For example, if the moving average is in the same area as the Fibonacci correction level, the price is likely to react to it (since two combined resistance or support levels are more significant than one).

If you have recalculated each ratio in the sequence of the above numbers, you may have noticed that the 0.5 ratio cannot be obtained in this way, but it is displayed as important in the Fibonacci correction level determination tool. The level 0.5 is included in the calculations of trading platforms, because practice shows that the price reacts to it very often both in terms of support and resistance.

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