Fibonacci Retracements

In this section I want to go into a bit more detail about  “Fibonacci” levels and how they can be used to identify potential areas of support or resistance.

Remember, the first thing we do when looking at a signal from Market Club is to put on our Fibonacci Retracement tool.

Before we look into the Fibonacci Tool in more detail, let’s have a look at exactly what Fibonacci numbers are.
Fibonacci numbers are an amazing marvel of mathematics. Put simply, Fibonacci numbers arise from a simple sequence. The first number in the sequence is 0, the second number is 1, and each subsequent number is found by adding the two previous numbers together, and you can see how that sequence works below:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377

Although this number sequence is believed to have been first observed by Indian mathematicians as long ago as 450BC, it is generally accepted that it didn’t appear in the western world until Leonardo of Pisa, aka Fibonacci, introduced them in the 13th century.

It is said that he actually discovered the sequence by imagining an idealized version of the breeding patterns of rabbits, but it’s not known whether or not that is the truth.

Fibonacci numbers and their related phenomena are simply amazing and they occur everywhere. For example, the florets in the center of a sunflower are always arranged in Fibonacci numbers. The flowering patterns of artichokes are arranged in Fibonacci numbers. The arrangement of pine-cones occurs according to Fibonacci numbers. Music can be arranged according to Fibonacci numbers, and there is even a famous painting by Debussy which is partly arranged by Fibonacci numbers. There is a building at the “Eden Project” in Cornwall, England, which has its structure based on Fibonacci numbers.

These are only a few of many examples! You can find out all sorts of fascinating Fibonacci information with a simple Google search.

In addition to Fibonacci numbers, the Fibonacci phenomenon also includes what we call Fibonacci “ratios”, and these are what you get when you divide certain numbers in the Fibonacci sequence with certain other numbers from the sequence.

For example, if you divide each number in the sequence by the number that follows it, you’ll get a number in the region of 62, and the further you go into the sequence you’ll find that, that number always hovers around the 61.8 mark. Therefore 61.8% is approximately the ratio of each Fibonacci number to the next.

Similarly, if you divide each Fibonacci number by the one after the next number, you usually end up with a ratio of in the region of 38.2%!

There are other such calculations, involving dividing by the number that comes two places after a certain number in the sequence, or three places after. By performing calculations like this you end up with certain important ratios, which are listed below:

23.6%, 38.2%, 61.8% and 76.4%

These percentages, along with 50% (which is not a Fibonacci number, but is simply a key common sense ratio) are then applied to the markets.

This means that you might, for example, look for resistance when a market re-traces 38.2% of a previous down-move, or perhaps you might look for support when the market retraces 61.8% of its last up-move.

Again, it’s not really known exactly why Fibonacci numbers should work this way in relation to the financial markets. There’s no logical reason why these numbers should apply to the markets in the way that they do, but the fact is that they quite simply do and the markets seem to respect them.

Fibonacci analysis of the markets is extremely popular and therefore once again, you find that the Fibonacci levels work as a self-fulfilling prophecy because so many traders around the world are acting on them.

So let’s take a closer look at Fibonacci retracements and how they work…

Remember, I use the Market Club’s charts and their Fib tool and it only has the following levels on it:

23.6% - 38.2% - 50% - 61.8%

There is also a 76.4% level that some use and you can add it onto MetaTrader as an example,  if you want to, but I find Market Club’s Fib Tool works well enough when you place it on different arms, as we will discuss:

Using the Fibonacci grids 

With Fibonacci retracements, what we are looking for is to see how far a market has retraced a certain previous move. The first thing you need to do therefore is find the move that you wish to study:

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In the example above, on a GBP/JPY daily chart, from today (10/10/2012) going back 6 months, we are looking to study the move from the high at point (1) down to the low at point (2). As you can see, after point (2) the market has begun rising – it has begun re-tracing the previous down-move. This is where we can use Fibonacci retracements, to see how much of that previous move has been re-traced.

To do this, we select the Fibonacci tool, and click on the start point of the move we wish to study, which in this case is point (1).The top of the wick of the candle and we drag the mouse straight down, until the 0% line touches the end point of the move – point (2), the bottom of the wick of that candle, and let go. This produces a Fibonacci grid based on that move:

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Arrow 3
Then it started retracing it's move and broke past the 23.6% level, but then hit resistance at the 38.2% level. Arrow and point 3.

Arrow 4
It even retested the 23.6% level before breaking through the 38.2% level, only to hit resistance at the 50% retracement level. The first arrow of point 4.

Arrow 5A
Then it made it's way back to the 38.2% level at Arrow and point 5A.

Arrow 4
Then back up to hit resistance again at the second arrow of point 4 and the 50% level.

Arrow 5B
You can then see that it is range bound between 38.2% resistance and 23.6% support levels right through to arrow and point 5B.

Arrow 6 & 7
Then it breaks through  the 38.2% resistance level and now 38.2% becomes support and the 50% level becomes resistance.

Then it breaks through the 50% resistance level and even breaks through the 61.8% retracement level.

Arrow 8 & 9A
But it retraces below the 61.8% level again and 50% now becomes support and 61.8% resistance.

Arrow 9A & 9B
To see arrow 9B, you need to look all the way back 6 months (look all the way to the left) and you will see that the 61.8% level it's at now, was previously a support level. That is why you need to put the Fibonacci on your charts over a few different time frames, e.g. 6 months, YTD = Year To Date, 1 year, 2 year, etc

Just have a look at the different retracement levels on that chart. Amazing how they certainly respect the different Fibonacci Retracement Levels!

When we are doing our trades, especially the Binary Option Trades, we want to be sure that there is no resistance in our way. Even when you have all your signals lined up, better to wait for it to break the resistance level.

Where to draw your Fibonacci grids

Quite simply, what we are looking for with Fibonacci retracements is to see how far the market retraces specific moves. It does take a little practice to figure out exactly where you need to be drawing your retracements.

But don't get caught in the trap of drawing them everywhere. That's a mistake.

The  general rule is this: You should draw Fibonacci retracement grids in two key places:
1) On entire trends
2) On the most recent move within a trend which has not yet been fully retraced.

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This time, same GBP/JPY day chart on a 6 month time frame, but now we are trying to see the retracement off the high point 3 to the low point 2. So the entire move from  a low to a high.

So,we start with putting our Fibonacci Tool on the lowest point of the wick on the low candle and drag our grid vertically upwards until the 0% line is lined up with the high point 3, then we let go.

The market is presently hitting a support level off the 38.2% level.

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Ok, same chart again, but this time taken within a trend that has not yet been fully retraced.

We can see that we are hitting a confluence of support/resistance level of 50% and 38.2%

Fibonacci Retracements Summary.

Fibonacci retracements are used to see how far a market has retraced a previous move – the popular levels to look for are 23.6%, 38.2%, 50%, 61.8%
• When used correctly, Fibonacci retracements are a very powerful method of finding support/resistance levels in the markets.
• The best way to use them is to draw a Fibonacci grid on an entire trend from beginning to end, and also on the most recent leg of the trend which has not yet been fully retraced.