FIBONACCI WHO

We will be using Fibonacci ratios a lot in our trading so you better learn it and love it like
your mother. Fibonacci is a huge subject and there are many different studies of
Fibonacci with weird names but we’re going to stick to two: retracement and
extension.

Let me first start by introducing you to the Fib man himself…Leonard Fibonacci.

Leonard Fibonacci was a famous Italian mathematician, also called a super duper uber
geek, who had an “aha!” moment and discovered a simple series of numbers that created
ratios describing the natural proportions of things in the universe

The ratios arise from the following number series: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89,
144 ……

This series of numbers is derived by starting with 1 followed by 2 and then adding 1 + 2
to get 3, the third number. Then, adding 2 + 3 to get 5, the fourth number, and so on.

After the first few numbers in the sequence, if you measure the ratio of any number to
that of the next higher number you get .618. For example, 34 divided by 55 equals
0.618.

If you measure the ratio between alternate numbers you get .382. For example, 34
divided by 89 = 0.382 and that’s as far as into the explanation as we’ll go.

These ratios are called the “golden mean.” Okay that’s enough mumbo jumbo. Even I’m
about to fall asleep with all these numbers. I'll just cut to the chase; these are the
ratios you have to know:

Fibonacci Retracement Levels

0.236, 0.382, 0.500, 0.618, 0.764

Fibonacci Extension Levels

0, 0.382, 0.618, 1.000, 1.382, 1.618

You won’t really need to know how to calculate all of this. Your charting software will
do all the work for you. But it’s always good to be familiar with the basic theory behind
the indicator so you’ll have knowledge to impress your date.

Traders use the Fibonacci retracement levels as support and resistance levels. Since so
many traders watch these same levels and place buy and sell orders on them to enter
trades or place stops, the support and resistance levels become a self‐fulfilling
expectation.

Traders use the Fibonacci extension levels as profit taking levels. Again, since so many
traders are watching these levels and placing buy and sell orders to take profits, this tool
usually works due self‐fulfilling expectations.
Most charting software includes both Fibonacci retracement levels and extension level
tools. In order to apply Fibonacci levels to your charts, you’ll need to identify Swing High
and Swing Low points.

A Swing High is a candlestick with at least two lower highs on both the left and right of
itself.

A Swing Low is a candlestick with at least two higher lows on both the left and right of
itself.

Let's take a closer look at Fibonacci retracement levels...

Fibonacci Retracement
In an uptrend, the general idea is to go long the market on a retracement to a Fibonacci
support level. In order to find the retracement levels, you would click on a significant
Swing Low and drag the cursor to the most recent Swing High. This will display each of
the Retracement Levels showing both the ratio and corresponding price level. Let’s
take a look at some examples of markets in an uptrend.

This is an hourly chart of USD/JPY. Here we plotted the Fibonacci Retracement Levels by
clicking on the Swing Low at 110.78 on 07/12/05 and dragging the cursor to the Swing
High at 112.27 on 07/13/05. You can see the levels plotted by the software. The
Retracement Levels were 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618).
Now the
expectation is that if USD/JPY retraces from this high, it will find support at one of the
Fibonacci Levels because traders will be placing buy orders at these levels as the market
pulls back.
Now let’s look at what actually happened after the Swing High occurred. The market
pulled back right through the 0.236 level and continued the next day piercing the 0.382
level but never actually closing below it. Later on that day, the market resumed its
upward move. Clearly buying at the 0.382 level would have been a good short term
trade.

Now let’s see how we would use Fibonacci Retracement Levels during a downtrend.
This is an hourly chart for EUR/USD. As you can see, we found our Swing High at 1.3278
on 02/28/05 and our Swing Low at 1.3169 a couple hours later. The Retracement Levels
were 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236). The expectation for
a
downtrend is if it retraces from this high, it will encounter resistance at one of the
Fibonacci Levels because traders will be placing sell orders at these levels as the market
attempts to rally.
Let’s check out what happened next. Now isn’t that a thing of beauty! The market did
try to rally but it barely past the 0.500 level spiking to a high 1.3227 and it actually
closed below it. After that bar, you can see that the rally reversed and the downward
move continued. You would have made some nice dough selling at the 0.382 level.

Here’s another example. This is an hourly chart for GBP/USD. We had a Swing High of
1.7438 on 07/26/05 and a Swing Low of 1.7336 the next day. So our Retracement Levels
are: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). Looking at the
chart, the
market looks like it tried to break the 0.500 level on several occasions, but try as it may,
it failed. So would putting a sell order at the 0.500 level be a good trade?
 If you did, you would have lost some serious cheddar! Take a look at what happened.
The Swing Low looked to be the bottom for this downtrend as the market rallied above
the Swing High point.

You can see from these examples the market usually finds at least temporary support
(during an uptrend) or resistance (during a downtrend) at the Fibonacci Retracements
Levels. It’s apparent that there a few problems to deal with here. There’s no way of
knowing which level will provide support. The 0.236 seems to provide the weakest
support/resistance, while the other levels provide support/resistance at about the same
frequency. Even though the charts above show the market usually only retracing to the
0.382 level, it doesn’t mean the price will hit that level every time and reverse.
Sometimes it’ll hit the 0.500 and reverse, other times it’ll hit the 0.618 and reverse,
and other times the price will totally ignore Mr. Fibonacci and blow past all the levels
like similar to the way Allen Iverson blows past his defenders with his nasty first step.
Remember, the market will not always resume its uptrend after finding temporary
support, but instead continue to decline below the last Swing Low. Same thing for a
downtrend. The market may instead decide to continue above the last Swing High.
 FIBONACCI
EXTENSION
The next use of Fibonacci you will be applying is that of targets. Let’s start with an example
in an uptrend.

In an uptrend, the general idea is to take profits on a long trade at a Fibonacci Price Extension
Level. You determine the Fibonacci extension levels by using three mouse clicks. First, click
on a significant Swing Low, then drag your cursor and click on the most recent Swing High.
Finally, drag your cursor back down and click on the retracement Swing Low. This will
display each of the Price Extension Levels showing both the ratio and corresponding price
levels.

On this 1‐hour USD/CHF chart, we plotted the Fibonacci extension levels by clicking on
the Swing Low at 1.2447 on 08/14/05 and dragged the cursor to the Swing High at
1.2593 on 08/15/05 and then down to the retracement Swing Low of 1.2541 on
08/15/05. The following Fibonacci extension levels created are 1.2597 (0.382), 1.2631
(0.618), 1.2687 (1.000), 1.2743
(1.382), 1.2760 (1.500), and 1.2777 (1.618).

Now let’s look at what actually happened after the retracement Swing Low
occurred.

• The market rallied to the 0.500 level

• fell back to the retracement Swing Low
• then rallied back up to the 0.500 level
• fell back slightly
• rallied to the 0.618 level
• fell back to the 0.382 level which acted as
support
• then rallied all the way to the 1.382 level
• consolidated a bit
You can see from these examples that the market often finds at least temporary
resistance at the Fibonacci extension levels ‐ not always, but often. As in the examples
of the retracement levels, it should be apparent that there are a few problems to deal
with here as well. First, there is no way of knowing which level will provide resistance.
The 0.500 level was a good level to cover any long trades in the above example since
the market retraced back to its original level, but if you didn’t get back in the trade,
you would have left a lot of profits on the table.

Another problem is determining which Swing Low to start from in creating the Fibonacci
Extension Levels. One way is from the last Swing Low as we did in the examples;
another is from the lowest Swing Low of the past 30 bars. Again, the point is that
there is no one right way to do it, and consequently it becomes a guessing game.

Alright, let’s see how Fibonacci extension levels can be used during a downtrend. In a
downtrend, the general idea is to take profits on a short trade at a Fibonacci price
extension level since the market often finds at least temporary support at these levels.

On this 1‐hour EUR/USD chart, we plotted the Fibonacci extension levels by clicking on
the Swing High at 1.21377 on 07/15/05 and dragged the cursor to the Swing Low at
1.2021 on 08/15/15 and then down to the retracement High of 1.2085. The following
Fibonacci extension levels created are 1.2041 (0.382), 1.2027 (0.500), 1.2013 (0.618),
1.1969 (1.000),
1.1925 (1.382), 1.1911 (1.500), and 1.1897 (1.618).
Now let’s look at what actually happened after the retracement Swing Low
occurred.

• The market fell down almost to the 0.382 level which for right now is
acting as a support level
• The market then traded sideways between the retracement Swing High
level and 0.382 level
• Finally, the market broke through the 0.382 and rested on the 0.500 level
• Then it broke the 0.500 level and fell all the way down to the 1.000 level

Alone, Fibonacci levels will not make you rich. However, Fibonacci levels are definitely
useful as part of an effective trading method that includes other analysis and
techniques. You see, the key to an effective trading system is to integrate a few
indicators (not too many) that are applied in a way that is not obvious to most
observers.
All successful traders know it’s how you use and integrate the indicators (including
Fibonacci) that makes the difference. The lesson learned here is that Fibonacci Levels
can be a useful tool, but never enter or exit a trade based on Fibonacci Levels alone.

Summary of Fibonacci
Trading
Fibonacci retracement levels are 0.236, 0.382, 0.500, 0.618, 0.764

Traders use the Fibonacci retracement levels as support and resistance levels. Since so
many traders watch these same levels and place buy and sell orders on them to enter
trades or place stops, the support and resistance levels become a self‐fulfilling
expectation.

Fibonacci extension levels are 0, 0.382, 0.618, 1.000, 1.382, 1.618

Traders use the Fibonacci extension levels as profit taking levels. Again, since so many
traders are watching these levels and placing buy and sell orders to take profits, this tool
usually works due self‐fulfilling expectations.

In order to apply Fibonacci levels to your charts, you’ll need to identify Swing High and
Swing Low points.

A Swing High is a candlestick with at least two lower highs on both the left and right of
itself.

A Swing Low is a candlestick with at least two higher lows on both the left and right of
itself.