What is the Fibonacci sequence?
The succession of Fibonnaci is defined in mathematics as a infitia succession of natural numbers as follows:
This succession begins with 0 and 1 and is from these that each number is the result of the sum of the previous two. Each of the elements of this succession is known as Fibonacci number. In the west it was initially described in Europe by an Italian mathematician named Leonardo de Pisa in the 13th century who was also known as Fibonacci. The Fibonacci theory currently has multiple applications in the field of mathematics, game theory, computing and even trading as we will see later.
Although many do not know, this numerical succession had been previously discovered by mathematicians of India in the 12th century by studying rhythmic patterns that were formed with syllables or the snitas of one or two pulses.
Without entering much detail about their mathematical properties, the Fibonacci succession has the following characteristics:
The ratio between each number (n) and the next (n + 1) in the series is always equal to 61.80%.
The ratio between each number (n) and the one following the next (n + 2) in the series is always equal to 38.19%.
If you make the division of any number of the Fibonacci series between the previous number as for example 34/21, 21/13, 144/89, 8/5, etc, the result will always tend to 1,618, which is the inverse of 0618.
If the division of any number of the succession is carried out between the next lower number not consecutive as for example 144/55, 55/21, 13/5, 21/8, etc, the result always tends to 2,618, which is the inverse of 0382.
In this case, the divergence between the result of those reasons and values such as 0618 or 1,618, is larger as the numbers used are smaller. Therefore the greater the number of employees of the succession, the more they will approach those limits.
These proportions were known since the antiquity and the Greeks gave it the name of "Reason Glow" to the proportion 1,618 and its inverse 0618. This radius, which is equal to its inverse plus the unit characterizes all the successions of its type, no matter what the initial number.
Once we understand these concepts we will see how the Fibonacci theory is used in trading:
Use of the Fibonnaci series in trading
In the field of financial markets the reality is that we are not too interested in the numbers of the Fibonacci series. What is interesting is the radios between the numbers that form the series which were defined in the previous section. These radios are used to determine levels of resistance or support, to locate price ranges, to identify objective prices to which the quotations of determined financial asset should be reached and to determine the period of time that possibly duraráun specific market movement. This information can be used by the trader to create strategies and to deepen the analysis of the market.
The levels or radios most used by operators are as follows: 23.6%, 38.2%, 38.4 and 161.8%. Some operators also tend to use levels 50% and 100%. Generally (though not always logically) the correction that occurs after a strong tendency movement (bullish or bearish) ends when it is next to the Fibonacci numbers 0318 or 0618 of the movement. In case the overall trend is bullish, these levels will work as supports but if it is bearish they'll work as resistances. Of course this does not mean that the correction in the market is going to end up in these levels with complete accuracy, but as levels of support or resistance it should be considered that there is a high probability that the correction will end in its proximity and the market resume its general trend. These are known as Fibonacci regressions.
To view the Fibonacci flashbacks in the chart, you must select two endpoints in the graph. They are usually applied to periods in which the market proves to have a clear tendency and are used to determine the levels in which the price when carrying out setbacks, is highly likely to bounce to give continuation to the trend.
The basic first here is that these countertrend movements normally stop at some of the Fibonacci levels as will be seen later in the examples. In the middle of the levels of 38.2 and 38.4 is usually formed a consolidation zone without clear tendency in which finally there is a turn that allows prices to continue with the main trend. But if the 38.4% Fibonacci level is traversed, the current correction is likely to be even greater and ends up correcting a larger stretch of the major trend. When this happens it should be taken as a sign that we can be faced with a change in the main trend of the market so we should be more careful in our operations.
Applying Fibonnaci levels in graphics
By placing the Fibonacci levels in a price chart, they allow us to divide the movements of the quotations in ranges or levels that are proportional to the spokes mentioned previously. As explained, each of these levels becomes a resistance or a support that can be used to determine target prices to open or close a market position. To better understand this concept we can see in the following chart for the EUR/USD pair a number of Fibonacci levels in which there is a high probability that Fibonacci regressions will occur (click on the figure to enlarge):
Looking at the chart above you might think it would be very easy to operate based on these levels. Clearly it can be seen as in several points of the Fibonacci radii the price rebounds and continues the upward trend. However if you look at the image you can find several breaks in these levels so it is important that the trader is careful and do not open a position automatically when the quotes approach the level 38.4% or 38.19% for example. Like any other indicator of technical analysis, Fibonacci radii can be very subjective in the sense that they provide a lot of leeway for interpretation and personal ideas. However as it will be seen then it is possible to counteract that subjectivity and to take advantage of the information that gives us the Fibonacci levels.
Where to set Fibonacci levels
To use the Fibonacci retracements in a quotation chart we must know where to place the anchors from which the respective levels will be calculated. First of all, estop depends on whether or not we are facing a bullish or bearish trend. If the market is in a bullish trend the anchor point 0% (level 0%) is placed at the maximum reached and point 100% (level 100%) in the minimum reached. If you take as an example the chart above can be seen as the price bounced on several occasions in the levels 23.6% and 38.2%, which are known and determined levels in advance and can be used as guides to open or close positions.
While it can be thought that what happened in this example is just a coincidence, the reality is that this type of relationship often occurs in all charts regardless of the time frame used, be it 5 minutes, 1 hour or 1 week.
The same graph shows an example of what could have been a trade using Fibonacci levels. In this case it shows a good gain/loss ratio, since the distance between the entry price and the stop loss (lower Fibonacci level) is considerably less than the distance from the entrance to the target price of profit. In this way Fibonacci regressions are a good tool to set stop loss, take profit and to operate with a good gain/loss radius.
Graphical examples of Fibonacci use
In the graph above it is possible to observe how Fibonacci levels were placed at the ends of a trend that lasted about a month during which the quotes fell from almost 1.2800 to 1.1925. Then, the price during the following year (approximately 9 months) fluctuated and was consolidated in the levels 23.6%, 38.2% and 38.4% to finally fall and finish through the level 0.0% continuing with the general trend of the market.
The following chart proceeds to move the anchor points from which Fibonacci levels are placed after the price reaches new minimum values. It can be seen as the consolidations of the previous levels in most cases, continue to coincide with the new levels. In this case could have left the highest Fibonacci level anchored in the maximum where it was before, however this is at the discretion of the operator which could consider instead place it in one of the most recent peaks so this example was run.
In the chart below, we move the Fibonacci tool anchors when at the price it reaches new minimum ends, and we observe how the consolidations in the old levels continue, for the most part, coinciding with the new levels. It could also have left the maximum anchored where it was previously, but most of the operators were already considering the most recent. The Red Arrows in the charts are used to indicate the displacement of the Fibonacci tool anchor.
Another observation that can be made with the previous chart is that in this case the maximum anchorage of keeps at the same price level as the previous one as they both match. What has varied is the minimum anchorage, which has been placed in the new minimum end that has been reached by the quotations of the asset. Again, short consolidations are being developed at the levels 38.2% and 23.6%, which indicates that the price behaviour takes into consideration these new levels.
As time passes and the market continues its course Fibonacci levels must be rearranged to the most recent endpoints. With this at the same time we are dividing the graph into shorter sections which the operator can use as entry points as follows:
The following chart has moved the lower anchor of the Fibonacci levels to a new minimum. You can see how the previous consolidations again coincide with the new levels, which are logically corridos. For example, the level that was previously 23.6% is now 38.2% and the same goes for others. At this point we must consider that this is not at all a coincidence, but the way in which this analytical tool works so that market quotes tend to respect these levels on multiple occasions. Generally, the levels where stronger consolidations occur are usually very clear when an analysis is carried out using Fibonacci regressions.
Final considerations
It is important that flashbacks or Fibonacci levels be calculated only after the end of a trend has been confirmed. This tool should never be used during a current trend.
If it is taken into account that any trend is part of a larger and longer term trend and in turn is formed by minor tendencies, the doubt arises on which of these tendencies the Fibonacci regressions should be calculated. There is actually no simple answer to this question. It can only be said that Fibonacci levels should be used in those tendencies that give clear signs of completion.
In general, weak tendencies experience a regression in the level 31.8% while strong tendencies usually present retrocessions at the level 38.4% before retaking the original direction.
The use of Fibonacci levels does not cease to have its detractors, especially those who base their criticism on the fundamentals of the theory of the random walk. These critics argue that there is no justification for stating that the movements of contributions have reason or reason to respect the Dee Fibonacci levels where there are supposed to be setbacks.
The Fibonacci levels applied in trading can be seen as an important part of Elliot's wave theory.
Some authors speak rather of critical areas located between levels 33% to 38.2% and 38.4% to 67% instead of the actual levels.
In trading techniques we include a tool for calculating Fibonacci levels to which you can access through the following link:
-Fibonacci Level Calculator
Some direct applications of the Fibonacci theory, in addition to the setbacks, in the analysis of the market are the following:
Fibonacci arcs.
Fibonacci Range.
Trading techniques that employ Fibonacci levels
Pure Trading System
ICWR Trading System
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