An Influential Italian: Fibonacci

This is commonly called a “price correction” or “Fibonacci retracement”. There are a lot of traders who lose when it comes to dealing with retracing markets because they a) try to trade a retracement thinking it’s a new trend, or b) panic during a retracement and exit unprofitably (versus being patient). If you’re in this boat, let’s fix the problem here and now – because understanding retracements can put pips in your account.

Leonardo Fibonacci (not Da Vinci), an Italian mathematician born around 1170 A.D., observed the relationship of sequences. His work is used in many applications, including but not limited to, engineering, space study, and the financial markets. He’s also credited with developing the decimal system. The point is this guy was no dummy. You can find out everything you ever (or never) wanted know to about Mr. Fibonacci by doing an Internet search on his name.

See how price retraced 50% of the move? It happens over and over and over and… you get the point.

Regarding the sequences mentioned above, in the markets we look for what are called the Fibonacci retracement numbers; the primary ones are 38%, 50% and 62%. Generally speaking, this means after price moves in one direction it often retraces or takes back 38%, 50% or 62% of the move.

Often, a retracement takes back 50% of the previous gain before continuing with the trend. A 38% retracement before continuing the trend might be considered very strong. On the other hand, if price retraces 62% of the previous move, a reversal may be on its way – consider this a “heads up” and watch for reversal signals!

So, to which Fibonacci retracement level is price likely move? For clues, identify S/R levels and pivot points – both may affect this. For me, this is where Fibonacci levels have the greatest significance. So, if a pivot point and Fibonacci level match up, you might want to pay attention.

Okay…

How can you, a trader, take advantage of Fibonacci? One way might be by exiting a trade and taking profits when the market begins to retrace, locking in profits. Then, you could re-enter in the direction of the trend at a Fibonacci or S/R level within the Fibonacci targets. Of course, there’s always risk, and here the risk is there may be a trend reversal happening.

The above said, there’s a way to monitor whether this is likely by checking on the strength of the trend. I’ll talk more about this later. Finally, aggressive traders might try to buck the trend (i.e., go against it) and ride a trade up to the retracement levels. But, as we’ve already established, this isn’t the best practice as it can be risky (remember: “The trend is your friend….) especially for novices.

Finding Fibonacci (Levels)

Establishing Fibonacci levels is easy. Using your price chart’s Fibonacci tool, click on one end of the prior move and drag your cursor to the other end of the move – from high to low or low to high. The 38%, 50% and 62% levels should appear on your chart (78.6% and 23.6% retracement levels are included in the above chart – you can set your desired values with most charting programs).

With your Fibonacci tool on your price chart, measure the beginning of the first move of the new trend by right-clicking at one end of the trend and dragging your cursor to the other end and right-clicking a second time. The Fibonacci levels will appear.

The above information sheds some light on how to get started with Fibonacci. We dig-in to this tool and the associated levels in the course, including how to use Fibonacci with the other AIME indicators.