Fibonacci retracement levels

Fibonacci extension levels

Fibonacci retracement levels refer to areas of support or resistance calculated by using the Fibonacci sequence. A central concept here is what’s called the Golden Ratio, which refers to 1.618 and it’s inverse .618. The Italian mathematician, Leonardo Fibonacci (1170-1250), is credited for bringing the sequence to the West. Using the sequence, Fibonacci noticed that certain ratios could be calculated, and that these correspond to “divine ratios” found throughout nature, architecture and art. To learn more, watch the video or continue reading below:

The Sequence and Ratios

For trading purposes, it’s sufficient to introduce the basic idea behind the Fibonacci sequence:

Trading the Fibonacci Sequence
The Fibonacci Sequence

The sequence extends to infinity and starts as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610……

After 0 and 1, each number is the sum of the two prior numbers, i.e. 0+1=1, 1+1=2, 1+2=3, 2+3=5, 5+8=13, 8+13=21, 13+21=34, 21+34=55 etc. The sequence used to calculate fibonacci retracement levels contains many unique mathematical properties:

  • If a number is divided by the previous number it approximates 1.618 (21/13=1.6153, 34/21=1.6190, 55/34=1.6176, 89/55=1.6181). The higher the numbers, the closer one will get to 1.6180.
  • When a number is divided by the next highest number, it approximates .6180 (13/21=.6190, 21/34=.6176, 34/55=.6181, 55/89=.6179 etc….). The higher the numbers, the closer one will get to .6180. This is the basis for the 61.8% retracement.
  • If a number is divided by another two places higher, it approximates .3820 (13/34=.3823, 21/55=.3818, 34/89=.3820, 55/=144=3819 etc….). The higher the numbers, the closer one will get to .3820. This is the basis for the 38.2% retracement. Also, 1 – .618 = .382 (!).
  • When a number is divided by another three places higher, it approximates .2360 (13/55=.2363, 21/89=.2359, 34/144=.2361, 55/233=.2360 etc….). The higher the numbers, the closer one will get to .2360. This is the basis for the 23.6% retracement.

Fibonacci retracements vs. Fibonacci extensions

Fib levels are used to identify potential reversal and extension scenarios. Following a strong uptrend, you can use Fibonacci retracement levels to predict the extent of a pullback. You can achieve the same during a downtrend, i.e. evaluating how far a counter-trend bounce may retrace. The levels from the current day are found by measuring the distance between the day high / low and dividing the vertical distance by the key Fibonacci ratios. The most commonly used Fibonacci retracement levels are 38.2% and 61.8%. Although the 50% retracement is not part of the Fibonacci sequence, it is almost always included as a point of reference (half the range).

Fibonacci Retracement Levels NinjaTrader 8
Fibs from current day – retracement levels

Fibonacci extensions are calculated when a move retraces more than 100% of its prior high/low (breakout). By applying the vertical distance from the prior high low and adding one of the key Fibonacci ratios to the prior high / low, one may locate target areas. For example, one may use the -138.2% level as a target for a breakout to the downside. Conversely, you can use the 138.2% extension as a target for a breakout to the upside. Of course, Fib extensions only come into play once the market is setting new highs or lows, and when there’s a lack of other clear support resistance levels.

Fibonacci extension levels
Fibs from prior day – extension levels

Validating Fibonacci Setups

You may combine Fibonacci retracement and Fibonacci extension levels with other indicators and price action scenarios. For example, consider using Volume Spread Analysis to identify imbalances between supply and demand. Generally, climax and churn bars can be used to identify when a pullback or bounce is likely to have run it’s course. We have created a short tutorial video on how to identify those scenarios using Bloodhound from Shark Indicators.

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Our Indicator Library for NinjaTrader 8 has a separate category with Fibonacci indicators, including Fibonacci retracement levels and extension from Current Day, Week, Month and N-Months as well as from the Prior Day, Week, Month and N-Months. Additionally this category also contains the Fibonacci Bands indicator.