Basics of Fibonacci Retracements for Crypto Traders
Technical analysis (TA) is one of two major approaches to trading, on a par with functional analysis (FA). Hence, it features a large number of tools, from basic candlestick charts and RSI indicators to comprehensive and all-around things like the Dow theory. But there’s one simple yet extremely popular instrument called the Fibonacci retracement or Fib.
The tool is based on the sequence proposed by a mathematician called Fibonacci back in the Middle Ages. Overall, its traces can be found in various objects, from atoms to galaxies to trading charts. And numerous traders often use it to determine support and resistance levels, find targets, and set Stop Loss orders. Today, let’s learn about the Fib retracements together with the experienced Superorder team.
Fibonacci Sequence Origins
The famous Fibonacci numbers are named after Leonardo of Pisa who is more known as just Fibonacci. He was an Italian mathematician of the 12th-13th centuries. Leonardo introduced the Arabic numeral system to Europeans but we know him thanks to his sequence, mostly. The thing is the Fib numbers are literally everywhere.
For instance, Fibonacci and his scholars found that numerous natural elements like flowers, shells, and constellations feature similar spiral shapes. Some experts think that these patterns also affect humans and our behavior. Long story short, the reason may lie in our attitude to changes: we want to soften them and come to the Fib levels, eventually.
The Underlying Fibonacci Principles
The Sequence
Well, let’s move to the numbers and retracements, finally! The sequence itself is pretty simple. Here’s the string:
- 0.
- 1.
- 1.
- 2.
- 3.
- 5.
- 8.
- 13.
- 21.
- 34.
- 55.
- 89.
- 144.
- 233.
- And so on.
The basic rule to find the next element is to sum two previous numbers. The sequence is infinite. One of its significant features is known as the golden ratio or 1.618. You can get this or similar ratio by dividing any number by the preceding number, for instance, 89 by 55. Of course, it’s better to exclude the first elements.
The next feature is the reversed division. Means, you can divide any number by the following one: 55 by 89 or 89 by 144. As a result, you will get the first retracement ratio which equals roughly 0.618 or 61.8%. The same principle can be applied to other levels that help traders and investors.
The Retracement
The Fib retracement relies on the mentioned reversal division. You already know the golden ratio for this concept but there are more points. For example, by dividing one number by the number that is two places ahead, you can get something near 0.382 or 38.2%. Move one place further, and you will get 0.236 or 23.6%. By extrapolating this trend, we get six key retracement levels:
- 0%.
- 23.6%.
- 38.2%.
- 61.8%
- 78.6%.
- 100%.
It’s possible to exceed 100% to get targets for more global trading strategies. The next numbers are known as the extension levels, here are their examples: 138.6%, 150%, 161.8%, 261.8%, and 423.6%.
Also, a lot of investors add 50% to this row. While it’s not a real part of the Fibonacci sequence, it represents the exact middle point. That’s why 50% also can help in your technical analysis, by showing the level where trends tend to continue.
Using Fib in Trading
Like in nature and art, the Fibonacci numbers play a crucial role in finance and, especially, trading. They can help to identify various areas: entry, target, stop, reversal, etc. Mainly, traders use them to find support and resistance levels.
Let’s look at how the Fibonacci retracement works. Almost all modern trading interfaces have automated drawing tools but you also can do it manually. Firstly, identify two key price points on the target chart: highs and lows of the chosen timeframe. Draw a line between these levels to get 0% and 100% points. There are two potential locations:
1.Uptrend. The low represents 100% here while the high is 0%. Four levels between these points show key potential support levels which will be likely tested during the market retracement (that’s why we call them the Fib retracements).
2.Downtrend. Respectively, the low point of the chosen downtrend is 0% and the high point is 100%. In this case, the Fibonacci numbers represent resistance levels that may be tested during the potential uptrend.
Ultimately, the tool helps traders on larger scales but it also can be useful for local trading. Let’s say you see that the price starts falling during the uptrend. Then, you can draw a line, identify levels, and set targets for two close points: buy 78.6%, sell 61.8%. Also, you will know that it’s better to avoid trading between core levels.
Needless to say that Fib isn’t the one and only TA tool you should use. It works best when you combine it with other indicators: RSI, MACD, moving averages, candlesticks. Moreover, it’s essential to use FA skills, too. Solely, the Fibonacci levels can’t help with your strategy but they can act as a great confirmation tool.
The Limits of Technical Analysis
Following the previous section, let’s also don’t forget that technical things such as charts or indicators are just formulas, not oracles. They can’t predict price movements. While the Fibonacci retracement seems to correlate with rates of BTC or stocks, there are dozens of examples when the Fib-related levels failed. Hence, you should remember about your own plan, mind other factors, and always do research!
