Fibonacci retracement levels /Fibonacci expansio levels refer to areas of support or resistance calculated by using the Fibonacci sequence. The central concept is 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:
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
One may use Fib levels 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. Locate the current day Fibs by simply measuring the distance between the day high / low, 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 available as a point of reference (half the range).
One may locate fibonacci extension levels 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. Keep in mind that 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.
Validating Fibonacci Setups
You may combine fibonacci retracement levels 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, you may use climax and churn bars to identify when a pullback or bounce is likely to have run it’s course. A short tutorial video on how to identify those scenarios using Bloodhound from Shark Indicators. Register via the form below to receive for more information:
Other Library Indicator
Our Indicator Library for NinjaTrader 8 has a separate category with Fibonacci indicators, including fibonacci retracement levels andfibonacci extension levels 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.
