The Magic of Fibonacci Retracement

Ahh, high school math! Did you ever think you would use it when you were 16 and learning about things like the mathematician Fibonacci, and his famous Fibonacci’s Sequence?

If you were a diligent math student you might remember what the Fibonacci sequence is. And if you were not, don’t worry, just keep reading and I will refresh your memory.

To begin, the importance of Fibonacci’s Sequence is that it is a pattern of numbers that occurs frequently in nature. This phenomenon is valuable because it appears in biological structures, and as I will discuss, economists believe the sequence even appears in the markets.

As such, using Fibonacci’s sequence it’s easy to predict the order of the sequence because it is a clear, recurring pattern.

What does this have to do with investing?

Investment strategies are applied to help the investor come up with intelligent predictions for market behavior. By using formulas such as Fibonacci Retracement, investors are able to do just that. With a common set of ratios, known as Fibonacci Retracement, investors can make educated guesses about the future behavior of a certain asset.

Fibonacci retracement levels are helpful for traders because they are a set of common ratios. These ratios are applied to different points on a graph. The ratios reveal patterned areas of support or resistance of an asset. The analytical tool has been proven helpful for investors. This is because the ratios reveal patterns that are often found in human behavior and biological structures.

Using retracement, investors, are able to apply this sequence of ratios in order to predict the next position of an asset. This requires historical data of a recent drop compared to a following peek (or the reverse).

This analysis has many uses and can be applied to any kind of security. The conclusions are useful for all kinds of investments, which includes cryptocurrencies. 

Applying Retracement

Just like other strategies, Fibonacci Retracement helps traders place effective stop losses or target prices in order to get the best price.

A stop-loss order means that a security or asset is bought or sold only when it reaches a desired set price. A stop price means that it is the limit at which the asset can be bought or sold. So only when the price drops below the “stop” price does it become a market order and can the order be put through.

Using a stop-loss helps to limit investors’ loss. And by applying Fibonacci Retracement, the idea is that there a greater degree of accuracy from an investor’s strategy.

0.618 and the Golden Ratio

As I mentioned, the reason that the Fibonacci sequence has any relevance for investors is that the results are historically demonstrable. That is, using this basic strategy, as well as others, investors have been able to make successful market analyses and predictions.

This phenomenon is part of what is often called the “Golden Ratio.” And the ratio 0.618. Therefore, Fibonacci retracements are often used by stock analysts to approximate the golden ratio.

Aside from the fact that it often yields good results, the Fibonacci sequence is a little mysterious. Nevertheless, it has been successfully applied to other trading techniques other than retracements, which includes: arcs, fans, and time zones.

And the fascination continues!

Interestingly, as I mentioned, the golden ratio is also frequently found in human responses. That is, when asked to choose between two “value-neutral” options, multiple studies show that the ratio is typically split between 62% and 38%, not 50–50.

Because of this fact, 62% is said to be the “Golden Ratio”.

The Retracement Ratios

Fibonacci retracement is produced by using two extreme points on a chart. Those points are then divided by the vertical distance with key Fibonacci ratios. 0.0% is considered to be the starting point of the retracement. And 100.0% is a complete reversal to the original part of the move.

When developing a Fibonacci Retracement with a stock chart, this is done by dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. With these ratios, horizontal lines are drawn which identify potential support and resistance levels.

Retracement is a concept applied to other market indicators such as Tirone levels, Gartley patterns, Elliott Wave theory, among others. Resistant levels are also important. Resistance or the movement of a price is applied to retracement strategies as well.

Elliot demonstrated that this basic phenomenon produced patterned results that were relatively predictable. One way of predicting these changes is with Fibonacci Retracement. 

Elliott Wave Theory is relevant to Fibonacci Retracement, as it is how the idea of using Fibonacci ratios in market behavior analysis came about. Elliot Wave Principle is also referred to as the Wave Principle. 

The theory embraces the idea that just as in nature, there are also recognizable patterns in market behavior. This is because the market is not an isolated environment, rather there is give and take with the mass psychology of those participating in them.

That means that both the market and human psychology are going to have an effect on one another. Take for example a company that stops producing a quality product. The market for the product decreases as people are no longer satisfied with it. However, once the product is improved, there is renewed value and so investors return.

The Magic of Patterns

In their paper, Exploring the Elliott Wave Principle to interpret metal commodity price cycles, authors Matias Marañon, and Mustafa Kumral explain how the technical analysis of market prices came to be a common practice.

We can credit Elliott of the study of applying Fibonnaci’s series to economics. The basic idea is that there are universal structures, and if that is the case then it is possible to predict the pattern of their occurrence.

Elliot first noticed such patterns when he realized that the waves in the market fit into the Fibonacci Series. Elliott applied those ratios to a study of the span of bull and bearish markets.

It was later that Elliott asserted the notion that these waves were connected by 0.618; the Golden Ratio. By demonstrating that the Golden Ratio occurred in multiple cases with different time and price amplitudes Elliott pioneered the technical analysis of market behavior. 

The problem with the idea is that it is only MOSTLY  true. There is no way to predict any event with perfect accuracy. So if you are looking for your crystal ball for playing the markets -then keep searching.

However, Elliott’s Wave and Fibonacci Retracement are useful to help human and algorithmic investors alike to search for patterns. They can then use the information the analysis offer to make better investment decisions.

Fibonacci Ratios

A Fibonacci retracement is different from a moving average because it is considered a static price. A moving average “moves” because it is calculated based on the past 50 or 200 days of market performance.

However, Fibonacci retracement applies certain ratios to market movement.

How does this work? The classic Fibonacci sequence looks like this:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987…

The sequence can continue on infinitely. And, it does not need to appear in whole numbers necessarily.

However, the most commonly ratios used for Fibonacci Retracement are: 23.6%, 38.2%, 50%, 61.8% and 78.6%.

These ratios express how much the price of an asset has corrected (gone down) or retraced (returned to a previous high).

These ratios are helpful for traders because based on the previous movement in the asset (up or down), they can use these ratios to predict the next retracement or correction. And with that information, they can place an accurate stop-loss order. 

Looking for the Pattern

For the Fibonacci tool to be used as a helpful analysis, an investor must first identify potential support or resistance levels. These are the “swing high” and “swing low” movements shown on a graph.

For the Fibonacci tool to be used as a helpful analysis, an investor must first identify potential support or resistance levels. These are the “swing high” and “swing low” movements shown on a graph.

Take a look at the graph below, which I have borrowed from Coindesk.

This graph is of Bitcoin’s behavior in September 2018. And demonstrates that the retracements of 0.236, 0.382, 0.5, 0.618, 0.786 were all expressed.

Here, NEO’s (NEO/BTC) swing low of 0.001834/BTC was connected to the swing high of 0.015170/BTC on the daily time frame using the Fibonacci retracement tool.

So by applying the Fibonacci retracement a trader would have been in a good position to predict Bitcoin’s movement for November. Using this information, the investor can decide to trade or buy depending on their needs.

A swing high is a “candlestick” at the peak of a trend. The candlestick can come from any time frame that demonstrated an obvious shift in value in the market.

On the other hand, a swing low is the “low candlestick stick” of a trend. That means that the higher low will be on either side.

With these points selected, you will need to use the Fibonacci retracement tool in your trading software to connect a low to a high. This low and high produces a potential support level. The support level is referred to as a “retracement.”

The retracement is then derived by dividing by the ratios in the Fibonacci sequence.

Fibonacci and Crypto

As with all trading strategies, it is always best when more than one is applied. Fibonacci retracement can be applied with moving averages or the relative strength index. The markets are tricky creatures! And understanding the movement of the market requires a great deal of thought.

And just like other strategies, Fibonacci retracement is not guaranteed. The value is that it expresses a pattern that frequently appears. But this is not an exact science.

Also, keep in mind that the newer the token, the harder it is going to be to pull historical data to find patterns. That does not mean that your new token cannot be analyzed. But you will have to rely on different strategies, as looking for patterns means that you are going to have to have data to perform retracement analysis.

Using your favorite explorer, you can pull similar data. And if you are ready to get fancy, you can also program your trading bot to do this kind of analysis. It is going to take more work, but using complementary technical analysis is going to improve your ability to make market forecasts. And with that information, your stop-loss orders have an opportunity to work harder for you. 

Also, be sure to check out our article on Best Tools for Crypto Charting to learn how these techniques can help with your own investment strategies.

Wrap-Up on Fibonacci

  • The most common retracement ratios are: 23.6%, 38.2%, 50%, 61.8% and 78.6%. These represent how much of a set of points on a graph of an asset move as the price is corrected and retraced.
  • The ratio is used to determine either an increase or a decrease in value. The percentage levels are used to determine future values. This information is helpful to place effective stop-loss orders.
  • Fibonacci retracements are a common technical analysis technique. They are used to predict if an asset will spike or drop, as well as its resistance levels. The indicator connects any two recent points that the trader deems to be relevant. They are looking for a high and low point. With this information, the investor can apply this information to make informed investment decisions.f
  • Fibonacci Retracement is more successful with high volume markets than with low volume markets. That means that cryptocurrencies like Bitcoin, Ethereum, Litecoin, which have a higher traded value are more likely to show retracement levels than minor tokens. This is because there is more measurable data. So, this is not a strategy that should be universally applied to all assets. 
  • Part of the benefit of Fibonacci retracement is that it helps to identify greater price trends. Strategists are always looking for trends in the market. It is important to remember that there are many factors acting on the market, which means that identifying trends means doing the work.

Savvy Analytics

  • Use other strategies and tools in conjunction with Fibonacci Retracement. This can be things such as the moving average. If you find that the results support one another, this is a very good signal that the markets are behaving the way you think they will. 
  • This technique can be used on any asset at any quantity. Fibonacci retracement relies on a ratio and not on a specific number. Indicators are merely statistics used to measure current conditions in order to gauge future financial and economic trends.
  • Fibonacci retracement levels are static prices because we are always applying the same ratios and looking for the pattern based on their relation to the horizontal line. So unlike moving averages, Fibonacci ratios will not change – otherwise, it would not be a pattern. The pattern is what enables investors to anticipate and act prudently to price changes. 
  • The basis of the strategy relies on the concept of cycles: that a series of events is repeated with recognizable patterns. However, Fibonacci Retracement, like Elliott’s Wave, is not a precise determination. One of the reasons for this is that the strategy is applied to different quantities and kinds of assets and securities.  So it is a principle that can be applied to distinguish patterns, but the exact numbers are going to be unique. It is the ratios that are important. 
trade predictions