Who and what is Fibonacci?
Leonardo Fibonacci (1170 – 1240) of Pisa, Italy was a thirteenth century mathematician who discovered that there was a relationship with adding numbers together and then the dividing relationship came up with repetitive percentage figures. This was called the Fibonacci summation or “series” numbers. Simply put, they are an infinite series of numbers that adds each number to the previous. An example is 1,2,3, 5,8,13,21,34,55,89,144, 233, 377, 610, 987 and so on. If you take 1 + 2 you get 3, then if you take 2+ 3 you get 5, and if you take 3 + 5 you get 8 and so on.
Fibonacci ratios are numbers derived from the calculations within the Fibonacci series numbers. The most common numbers are .382%, .50%, .618%, .786%, 1.00%, 1.272% and 1.618%. The “Golden ratio” number is often referred to for the number .618% due to the many coincidences that reoccurs with that number. For example 89=+/- .618 of 144, 144 divided by 233 + .618, .382 + .618 = 1.00, .786 = the square root of .618%.
Fibonacci correction- also referred to as a retracement, when a market makes a move from a low to a high, price will have a tendency to pullback, retrace or correct. The percentage of the pullback can be .382%, .50%, .618%, .786% and at times even 100%. When looking for bullish set-ups it makes sense that we want to target buying opportunities especially on pullbacks when the market is in an up-trend. This is when we will use a Fibonacci tool to identify the percentage figure and look for that as a potential support to enter a long position.
Fibonacci extensions – There are times when a pullback can retrace beyond the original starting point and exceed 100 percent of the initial wave or trend. So a Fibonacci extension is essentially a correction that exceeds the low of the initial trend. Technicians will use the 100 percent, 1.272 percent and 1.618 percent ratios to target a pullback level. This state of correction can be considered a double bottom at the 100 percent pullback level, and when we see that correction exceed the low of point “A”, we see raids on stops. By using the extension tool you may have a great place to place your stops and keep them out of harms way by using the “hidden” or invisible support level as determined by the Fibonacci extension technique.
Fibonacci projections – this is the term referred to as simply determining a potential price objective and is a vital component in Elliot wave theory. It is an excellent confirmation tool to identify potential trend exhaustion turning points. Using the Fibonacci calculator, one can determine a bullish upside objective by measuring the range of the wave or the swing as it is also referred to. Multiply that sum by the corresponding ratios which are .618 percent, 100 percent, 1.618 percent, 2.618 percent and for extreme moves 3.618 percent. In a bullish trend add that figure to the low or point “C” , which is the correction low and this will give you the projected price objective. This calculator on my website does this for you automatically.
Fibonacci analysis works with day trading to determine support and resistance levels within the Pivot Point areas as well as helping to forecast the projected ranges. The Fibonacci correction tool can be used as a way to identify if the trend will reverse or if the trend will continue. Here is how you can put Fibonacci correction levels to good use while integrating them with pivot point support and resistance numbers. This is a technique that is more in line with what day traders will encounter on a more frequent basis. as a system or rule based trader you need to wait until there is confirmation of a breakdown of either support or a conditional change in prices by a series of lower highs, lower closes than opens lower lows, closes below prior lows and most importantly you want confirmation of a sell signal when the market closes below the low of the doji. The trigger to sell would be on that candles close or the next time periods open, the stop would be placed initially as a stop close only above the high of the doji. Immediately we see instant gratification as prices plunge. But as what can normally occur is an upside correction that takes place, in this example the correction takes form of a consolidation period that lasts nearly one hour and forty five minutes. It is during this indecision period that can create havoc, doubt and uncertainty in which your mind starts to play tricks on you. This is the consolidation period that generates indecision. At this point you have a good set-up, prices have violated support, resistance has held, there is a high probability pattern that you recognize that generates reliable price action, namely the Low close doji sell signal. But you are faced with these internal forces that may cause you to exit a well defined trade. After all you have a risk factor and a potential reward objective already mapped out. However this consolidation period is creating more and more doubt whether or not you should stay in the trade. Here is when you need to take advantage of the time the market is in the pause period and go to work. You now have a distinguishable high and a low made. Using the Fibonacci ratios you determine the correction levels. As such you have identified that the 50% and the .618% Fibonacci retracement levels are holding the market down. Armed with this information you will not be surprised or forced to react emotionally when prices rebound but do not penetrate above these levels. As the chart shows, the correction hits the .618% retracement level as defined by point “C” and almost immediately prices collapse. The market rewards the disciplined and patient trader, as such Fibonacci correction levels will help you to identify what I consider pattern traps. For the market to finally fall out of bed like it does this period of consolidation attracted buyers and that congestion pattern when it fails to support forces these traders to sell like mad. If you want more information on how to use Fibonacci with pivot points, these tactics are revealed in my latest book.
All the best,
John L. Person lll