If you are an active day trader, you are probably aware that Fibonacci retracement and extension levels are some of the most important and useful tools in all of price action.
Day traders and technical analysts can use Fibonacci levels analysis to confirm an entry-level, target a take profit, and to determine your stop loss level.
In this guide we will explain exactly how to draw Fibonacci levels, so that you can make better decisions about when to get in and out of trades.
What are Fibonacci numbers and ratios?
Fibonacci sequence, also sometimes referred to as The Golden Ratio, is a series of numbers where each number is a sum of the previous two numbers.
For example, with the string 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, if we add 0+1, we get 1. If we add 1+1, we get 2. If we add 1+2, we get 3, and so on forever down the sequence.
The resulting sequence is known as the Fibonacci sequence and each of number in the sequence is called a Fibonacci number. The Fibonacci ratios are then calculated by dividing numbers across the sequence. These calculations then give us the following ratios that are used in the Fibonacci levels.
The ratios get translated into percentages – 23.6%, 38.2%, 61.8%, 78.6%, etc. – which are then applied to the chart to try and identify potential hidden support or resistance levels in the market.
The Fibonacci sequence was discovered in 1202 by an Italian mathematician known as Leonardo of Pisa, while considering a practical problem involving the growth of a hypothetical population of rabbits based on idealized assumptions.
This sequence governs many aspects of life; from the creation of flowers, the formation of waves, to proportioning of the human body. It also provides the information that traders and technical analysts need to formulate resistance and support levels which can be used within a risk management framework.
You can use Fibonacci retracement levels on their own or combine them with other trading methodologies.
The Fibonacci sequences were used to formulate other theories such as the Elliot Wave Principle and Dow Theory. You can also use Fibonacci ratios with other technical analysis tools.