Part 5 Technical Analysis – Using the Fibonacci Line

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Part 5: Technical Analysis – Using the Fibonacci Line

Hello, and welcome to another episode of technical analysis show for trading binary options. Today I will show you detailed examples of trading while using one of the most basic things – Fibonacci lines. We will learn how to draw the lines, how to use it to trade, but also a neat little trick. An indicator, which draws the line for us.

What are Fibonacci lines?

Figure 1: Connect the local minimum (A) and maximum (B) F.L. tool.

Fibonacci lines are a very popular tool, used by the majority of professional traders. These lines are based on the use of numbers identified by mathematician Leonardo Fibonacci. This series of numbers (0, 23.6, 38.2, 50, 61.8, 100) can be used in trading, because the price often makes reversals at these lines.

The lines are very easy to draw. See Figure 1

Figure 2: The drawn lines

Just use the Fibonacci lines tool and connect those two said points. This gives us something similar to what we can see in the Figure 2

Now we can see that in the vicinity of the aforementioned lines, the price broke (see Figure 3) and (at least short-term) turnover has happened. I will tell you right now how can this be utilized.

Figure 3: Price reversals, which we can use.

How To Trade Binary Options Using The Fibonacci Line?

Check out the Figure 4 We have marked F.L. (Fibonacci lines) thanks to previous swing (orange points A and B) and now we can happily trade. Look at how many opportunities (marked by the blue circle) to trade were provided by the F.L.

Figure 4: Trading

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The Best Fibonacci Lines

The best lines on which the turnover almost always occurs are the 0, 50 and the 100 lines.

Author

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I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

Fibonacci and the Golden Ratio

There is a unique ratio that can be used to describe the proportions of everything from nature’s smallest building blocks, such as atoms, to the most advanced patterns in the universe, like the unimaginably large celestial bodies. Nature relies on this innate proportion to maintain balance, but the financial markets also seem to conform to this “golden ratio.” Here, we take a look at some technical analysis tools that have been developed to take advantage of the pattern.

The Mathematics

Mathematicians, scientists, and naturalists have known about the golden ratio for centuries. It’s derived from the Fibonacci sequence, named after its Italian founder, Leonardo Fibonacci (whose birth is assumed to be around 1175 A.D. and death around 1250 A.D.). In the sequence, each number is simply the sum of the two preceding numbers (1, 1, 2, 3, 5, 8, 13, etc.).

Key Takeaways

  • The golden ratio describes predictable patterns on everything from atoms to huge stars in the sky.
  • The ratio is derived from something called the Fibonacci sequence, named after its Italian founder, Leonardo Fibonacci.
  • Nature uses this ratio to maintain balance, and the financial markets seem to as well.
  • The Fibonacci sequence can be applied to finance by using four main techniques: retracements, arcs, fans, and time zones.

But this sequence is not all that important; rather, the essential part is the quotient of the adjacent number that possess an amazing proportion, roughly 1.618, or its inverse 0.618. This proportion is known by many names: the golden ratio, the golden mean, PHI, and the divine proportion, among others. So, why is this number so important? Well, almost everything has dimensional properties that adhere to the ratio of 1.618, so it seems to have a fundamental function for the building blocks of nature.

Prove It

Don’t believe it? Take honeybees, for example. If you divide the female bees by the male bees in any given hive, you will get 1.618. Sunflowers, which have opposing spirals of seeds, have a 1.618 ratio between the diameters of each rotation. This same ratio can be seen in relationships between different components throughout nature.

Are you still having trouble believing it? Need something that’s easily measured? Try measuring from your shoulder to your fingertips, and then divide this number by the length from your elbow to your fingertips. Or try measuring from your head to your feet, and divide that by the length from your belly button to your feet. Are the results the same? Somewhere in the area of 1.618? The golden ratio is seemingly unavoidable.

But does that mean it works in finance? Actually, financial markets have the very same mathematical base as these natural phenomena. Below we will examine some ways in which the golden ratio can be applied to finance, and we’ll show some charts as proof.

The Fibonacci Studies and Finance

When used in technical analysis, the golden ratio is typically translated into three percentages: 38.2%, 50%, and 61.8%. However, more multiples can be used when needed, such as 23.6%, 161.8%, 423%, and so on. Meanwhile, there are four ways that the Fibonacci sequence can be applied to charts: retracements, arcs, fans, and time zones. However, not all might be available, depending on the charting application being used.

1. Fibonacci Retracements

Fibonacci retracements use horizontal lines to indicate areas of support or resistance. Levels are calculated using the high and low points of the chart. Then five lines are drawn: the first at 100% (the high on the chart), the second at 61.8%, the third at 50%, the fourth at 38.2%, and the last one at 0% (the low on the chart). After a significant price movement up or down, the new support and resistance levels are often at or near these lines.

Created Using MetaTrader

2. Fibonacci Arcs

Finding the high and low of a chart is the first step to composing Fibonacci arcs. Then, with a compass-like movement, three curved lines are drawn at 38.2%, 50%, and 61.8% from the desired point. These lines anticipate the support and resistance levels, as well as trading ranges.

Created Using MetaTrader

3. Fibonacci Fans

Fibonacci fans are composed of diagonal lines. After the high and low of the chart is located, an invisible vertical line is drawn through the rightmost point. This invisible line is then divided into 38.2%, 50%, and 61.8%, and lines are drawn from the leftmost point through each of these points. These lines indicate areas of support and resistance.

Created Using MetaTrader

4. Fibonacci Time Zones

Unlike the other Fibonacci methods, time zones are a series of vertical lines. They are composed by dividing a chart into segments with vertical lines spaced apart in increments that conform to the Fibonacci sequence (1, 1, 2, 3, 5, 8, 13, etc.). Each line indicates a time in which major price movement can be expected.

Created Using MetaTrader

The Golden Ratio can be applied to everything from nature to human anatomy to finance.

The Bottom Line

Fibonacci studies are not intended to provide the primary indications for timing the entry and exit of a position; however, the numbers are useful for estimating areas of support and resistance. Many people use combinations of Fibonacci studies to obtain a more accurate forecast. For example, a trader may observe the intersecting points in a combination of the Fibonacci arcs and resistances.

Fibonacci studies are often used in conjunction with other forms of technical analysis. For example, Fibonacci studies, in combination with Elliott Waves, can be used to forecast the extent of the retracements after different waves. Hopefully, you can find your own niche use for the Fibonacci studies and add it to your set of investment tools.

What Is Fibonacci Retracement and Where Do Its Ratios Come From?

A Fibonacci retracement is a popular tool among technical traders. It is based on the key numbers identified by mathematician Leonardo Fibonacci in the 13 th century. Fibonacci’s sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series.

In technical analysis, a Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels.

Key Takeaways

  • A Fibonacci retracement is a popular tool that traders can use to identify support and resistance levels, and place stop-loss orders or target prices.
  • A Fibonacci retracement is created by taking two extreme points on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%.
  • Fibonacci retracements suffer from the same drawbacks as other universal trading tools, so they are best used in conjunction with other indicators.

Fibonacci Retracement

How the Fibonacci Sequence Works

Before we can understand why these ratios were chosen, let’s review the Fibonacci number series.

The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms, and the sequence continues infinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies.

The key Fibonacci ratio of 61.8% is found by dividing one number in the series by the number that follows it. For example, 21 divided by 34 equals 0.6176 and 55 divided by 89 equals 0.6179.

The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example, 55 divided by 144 equals 0.3819.

The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example, 8 divided by 34 equals 0.2352.

Fibonacci Retracement and Predicting Stock Prices

For reasons that are unclear, these Fibonacci ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset’s price to reverse.

Fibonacci retracements are the most widely used of all the Fibonacci trading tools. This is partially due to their relative simplicity and partially due to their applicability to almost any trading instrument. They can be used to identify and confirm support and resistance levels, place stop-loss orders or target prices, and even act as a primary mechanism in a countertrend trading strategy.

Fibonacci retracement levels use horizontal lines to indicate where possible support and resistance levels are. Each level is associated with one of the above ratios or percentages, indicating the percentage is how much of a prior move the price has retraced. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above.

The following chart illustrates how a Fibonacci retracement appears. Most modern trading platforms contain a tool that automatically draws in the horizontal lines. Notice how the price changes direction as it approaches the support/resistance levels.

In addition to the ratios described above, many traders also like using the 50% level.

The 50% retracement level is not really a Fibonacci ratio, but traders often like it because of the overwhelming tendency for an asset to continue in a certain direction once it completes a 50% retracement.

Fibonacci Retracement Pros and Cons

Despite the popularity of Fibonacci retracements, the tools have some conceptual and technical disadvantages that traders should be aware of when using them.

The use of the Fibonacci retracement is subjective. Different traders may use this technical indicator in different ways. Those traders who are profitable using the Fibonacci retracement verify its effectiveness; those who lose money say it is unreliable. Some argue technical analysis is a case of a self-fulfilling prophecy. If traders are all watching and using the same levels or the same technical indicators, the price action may reflect that fact.

The underlying principle of any Fibonacci tool is a numeric anomaly that is not grounded in any logical proof. The ratios, integers, sequences, and formulas derived from the Fibonacci sequence are only the product of a mathematical irregularity. This is not inherently wrong, but it can be uncomfortable for traders who want to understand the rationale behind a trading strategy.

Furthermore, a Fibonacci retracement strategy can only point to possible corrections, reversals, and countertrend bounces. This system struggles to confirm any other indicators and doesn’t provide easily identifiable strong or weak signals.

The Bottom Line

Fibonacci trading tools suffer from the same problems as other universal trading strategies, such as the Elliott Wave theory. That said, many traders find uses for Fibonacci retracements and have found success using them to place transactions within greater price trends.

Fibonacci retracement can become even more powerful when used in conjunction with other indicators or technical signals. Investopedia Academy’s Technical Analysis course covers these indicators as well as how to transform patterns into actionable trading plans.

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