I've had a few questions about this lately, and as I want to be educational (as well as making people profits) so when you're on your own, you can make decisions based on analysis, statistics and theory and not emotion like most noobs in this space.
So, without going deep into what the fibonacci numbers actually are, I'll give you a quick rundown and then I'll explain why they are significant.
The fibonacci sequence is a series of numbers that come to fruition by adding the sum of the previous numbers together eg. 0, 1, 1, 2, 3, 5, 8, 13, 21, 34 etc.
Following this, we could work out the next few numbers...
21, 34, 55, 89 etc.
However, if we look at the inverse relationships of these numbers, we can work out 'ratios'. Ie. if I divide the last number by the previous number, we get a value that as the numbers increase, the ratio gets closer and closer to what is known as 'The Golden Ratio'.
The Golden Ratio is 1.6180339 to 7 decimal places. If you have ever used fibonacci retracements you should recognise this number. It appears a lot on charts when the fib tool is on.
Now I'm going to try and explain why we use them....
So this number occurs naturally in everyday life (google this, it's fascinating. It's literally in our DNA) but we've also been able to spot it on trading charts. But obviously I'm going to stick to why they are useful in trading.
So, when we look at charts we can clearly see trends occuring. These are formed in waves, which is shown by candles on the chart. If we continue to get higher highs and higher lows, we are in an uptrend. On the flip side, we are on a downtrend.
So fibonacci lines are used for 2 reasons, to project potential buy and sell targets and where to project we will get support/resistance. In my opinion these are kind of the same thing, as I usually sell just BEFORE I feel institutional money will sell (that's essentially what resistance is). Because retail investors and institutional investors use this tool, we can use it with great certainty that what we project will play out.
So firstly, on an uptrend (shown below with AION chart) I have plotted the fibonacci retracement tool from the start of the trend to the finish. I always go absolute low to absolute high unless there's some weird price action like big long wicks on the candles. If I feel it's not a representation of the trend, I'll go from where I feel the absolute top/bottom is regardless of the wicks poking through. This is the way we always plot it. With the trend. You should now see horizontal lines drawn across your chart, with corresponding numbers attached.
Now you can see that there is a bit of support around the 0.618 region. Remember the Golden Ratio? :)
What this means is that the trend has retraced 61.8% from the previous uptrend.
- 1 divided by 1.618 is 0.618.
Now you're probably even more confused about what the hell this number is and why it's significant, but the only short explanation I can give without going into serious mathematics is:
It just is. It occurs in nature everywhere, and we can't work out why. But it's significant as hell.
If we can spot it in our DNA and on our hands and arms then I'm going to trust that seeing it on a chart is significant.
So back to the topic at hand. How to use it?
Well, it's simple really. We know that on trading charts we tend to retrace to the 0.5 or 0.618 regions, so we can use this in our trading strategy to maximise risk:reward ratio. Here's two simple rules I use everyday when using fibonacci retracements -
On an uptrend, we use the fibonacci tool to project where we will retrace to. We may buy at the 0.5 or 0.618 levels if we reach them.
On a downtrend, we use the fibonacci tool to project profit targets. The 1.618 number is a great target for a strong uptrend starting.
There you have it. Basic fibonacci skills that will improve your trading. I will expand on this in the future, but I think this is a great start to my educational content.
Any questions, holla. I'm here.
Peace.
- B