How to use Fibonacci Retracement and Extension ?

What is Fibonacci Retracement ?

Fibonacci retracement is one of the most popular tools among technical analysts. It is generally used to figure out possible support and resistance levels. These levels are horizontal lines representing a percentage based on the Fibonacci sequence, A mathematical formulae founded in the 13th century.

Each Fibonacci retracement level is Identified by a percentage, The percentage is how much of a prior move has the price retraced. Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%, and while not officially a Fibonacci ratio, 50% is also used as a level due to its psychological importance.

How to Use Fibonacci Retracement ?

Fibonacci retracement works in every time frame and in every segment. In order to draw Fibonacci retracement, the trader should first analyze the trend of the market. Fibonacci retracement is drawn by placing the grid from low to high in an uptrend and from high to low in a downtrend. Set the grid to display the .382, .50, .618, and .786 retracement levels.

This image  demonstrates hoe to use Fibonacci retracement on the charts

Fibonacci Retracement works best in trendy markets, As we can see in the weekly chart above, After creating a small supply zone, Nifty retraces from 50% Fibonacci retracement level providing a good opportunity to take up a buying position. Fibonacci retracement works in all kinds or markets, time-frames, and Trends.

What is Fibonacci Extension?

Fibonacci Extension is a tool used to determine how far price can travel after a pullback. Fibonacci extension is one of the most reliable tools to establish profit targets, Fibonacci Extension levels are also possible areas where price may reverse. Trend based Fib Extension tool or Fibonacci Extension provides results in every kind of market and in all time frames.

How to Use Fibonacci Extension?

Unlike Fibonacci retracement which is plotted by joining 2 points (swing high and swing low), Fibonacci Extension is drawn by joining 3 points. In an uptrend fib Extension is drawn by joining the lowest point, the highest point and the low of the retracement or pullback.

This image is an example of Fibonacci extension and retracement trading strategy
As we can see in the chart above, After the price retraced from 50% Fibonacci Retracement level, the price continued to move upwards till the highest level provided by the Fibonacci extension tool, After which the price went into a sideways motion, indicating a possible reversal. While trading with the Fibonacci extension tool, 0.618 Fibonacci Extension level is considered as the ideal target, a trader should only expect the price to reach the above Fibonacci levels when the price sustains above 0.618 level with strong momentum.

How to Trade with Fibonacci ?

While trading with Fibonacci retracement and Extension It is essential to understand that Fibonacci Levels are a confirmation tool. Due to this reason, Fibonacci is best used alongside other technical tools and indicators such as Trend lines, RSI, Volume, Moving averages and MACD. A signal is only trustable when confirmed by multiple Indicators.

Here is an easy yet effective Fibonacci trading strategy:-

Plot a Fibonacci Retracement by connecting the lowest and the highest point in an uptrend. Set the grid to show horizontal lines representing 23.6%, 50%, 38.2% and 61.8% Fibonacci Retracement levels. Now, wait for these horizontal lines to act as a retracement zone during a pullback. take up a buying position at these retracement points, Put your stop loss at the very next Fibonacci level. Use the Fibonacci extension or Trend based fib extension tool to Determine the exit or the booking point. Plot the Fibonacci extension by joining the high, the low, and the retracement point. Horizontal lines will appear on the chart, each line represents a Fibonacci Extension level. Consider the 0.618 level as the ideal target or exiting point. However in a strong Bullish market Price may sustain above the 0.618 level, In which case a trader can aim at the above levels after trailing the stop loss below 0.618 level.

Fibonacci Retracement + MACD

Another popular method of Trading with Fibonacci Retracement is to Combine it with the well Known MACD indicator. In this method, we try to catch points where price interacts with important Fibonacci retracement levels in conjunction with MACD crossovers. we treat these points as our entry signals. we hold the stock until we see another MACD crossover from the opposite direction. Another way of identifying an exit point is to Use the Fibonacci Extension tool and mark 0.618 Fib extension level as the Target.



The Bottom line

Fibonacci Retracement and Extension are harder to trade than they look. These levels are best used as a tool within a broader trading system. Not everyone is a fan of the Fibonacci Tool’s, Some people consider them as “Just another hyped indicator” However even for the sceptic Fibonacci can add an extra level of insight to potential market turning or continuation points. Which one might not be able to foresee at a glance.




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