There’s a lot of ways to look at a market, but the vantage point that one is using will likely have some impact on their net results. Regardless of how one is approaching a market, the necessity of good levels is a constant. Levels help to define the context around that market, helping to set stops and find targets. They can also be used to glean biases, as particular price levels can carry a large bearing and a market trading above/below such a level can be sending a message in and of itself.
The challenge then becomes how to find those levels. And one of the more popular methods of finding levels is also rooted in one of the most important mathematical concepts found in nature. That’s Fibonacci.
If mathematics is rooted in the world around us, then Fibonacci is God’s language. Numbers are man made, but the Golden Ratio is discovered, and its found throughout the world around us, even in places that we didn’t know or can’t see. I believe it’s relevant in markets, as well, as human beings have no choice but to run according to the stride that nature set.
What is Fibonacci?
The Fibonacci sequence is as follows: 0, 0, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, etc.
to find the next number in the sequence, simply add the prior two digits.
What’s amazing is that regardless of how far we go in this sequence, which stretches to infinity, each number will be 61.8% of the next number, and this is the Golden ratio.
The golden ratio can also function as support or resistance on a trading chart. This can be set up on most charting packages with the Fibonacci retracement tool, which will then plot levels based on percentages derived from the Fibonacci sequence.
There’s more than just the 61.8% retracement that can be taken from Fibonacci. If you divide any digit in the sequence into the number two places to its right, you’ll arrive at .382, or 38.2% which is another figure used in Fibonacci analysis.
The two levels looked at above are a large part of Fibonacci analysis. But, this can be taken to even greater depths, utilizing retracement ratios at 14.4%, 23.6%, 50%, 76.4%, 78.6%, and 88.6%. It’s important to note – 50% actually has zero pertinence to Fibonacci, but has been applied as a ‘half-way’ point for years. Many traders also use that 50% retracement as a trend switch; as in, if prices retrace more than 50% of the prior trend, then the prior trend is no longer workable and instead traders could look to trade in the other direction.
With more levels applied on the chart, the number of tradeable setups begins to increase; but you’ll probably notice from the above chart that not much additional context was gleaned by adding these additional levels, and there’s a few reasons for that, one of which is the time frame.
The above chart is a monthly chart of the US dollar and we’re looking at more than 20 years of pricing data. There’s not going to be many tradeable opportunities on a chart that prints but one single candle per month; but, to be sure, if and when these levels come into play they can bring powerful results on a short-term basis.
Take, for instance, the support inflection off of that 38.2% retracement that took place in early 2021 trade. And then again in March. And then again in May. Each time prices put in a prolonged reversal, even if weakness remained in the mix (as illustrated by the three separate tests of support).
But to make Fibonacci even more usable, traders can lean on their timeframes. By going down to the weekly chart, I’ve identified a major move spanning from the 2017 high down to the 2018 low, and neither the high nor the low has been traded through, making this a still valid move to use for analysis. I’ve applied a Fibonacci retracement around that major move in red on the below chart.
Locate the Confluence to Find the Power
The benefit behind having multiple Fibonacci retracements is not only in that we have many more workable levels, but we also have areas of ‘confluence,’ or multiple mechanisms of support/resistance in the same area, thereby giving those zones on the chart potentially even more power because there’s now multiple reasons for traders to come in to buy/sell at a particular spot. From the above chart, there’s a few of these that can be identified, I’ve marked each with a blue box on the below chart.
Digging Even Deeper
At this point we’ve discovered a number of great usable levels from longer-term charts, but we can drill down even further to get some workable context. The Daily chart below also includes another shorter-term Fibonacci retracement in Green. But, now that we have this third study applied, we can get workable levels that will provide 4 or 5 tradeable setups per month, and that’s from a Daily chart. This can be drilled down even further, such as a four-hour chart, although the shorter-term we go on the analytical base, the more error-prone the strategy will become.
On the below chart, I’ve identified the one area of confluence with a green box; and if price comes up to this area and stalls, that opens the door for a short. But the general gist of the strategy is the same as trading support or resistance: Look for price to run to the level. If it stalls, the level may be playing out, at which point execution could be investigated. Stop goes on the other side of the level so if the level doesn’t hold, loss mitigation becomes priority. And then don’t watch it, because you’re probably not going to do it any favors.
Ok, one more Fibonacci retracement, and this time it’s applied on the four-hour chart.
This is a chart that can be used for short-term trading, what many would often call ‘swing trading’ where the trader is looking to hold positions for anywhere from a few hours to a few days or perhaps even a couple weeks.
The shorter-term Fibonacci retracement has been applied in purple on the below chart, and I’ve added a green box around the two items of confluence and a red box around the 50% marker.
From the above chart, notice how the low on the right side gets caught in the green box, which is a confluent area between the 88.6% retracement of the short-term move and the 23.6% retracement of the move we applied on the weekly chart. But there’s another item of confluence, and that’s around the 61.8% retracement of the short-term Fibo and the 38.2% retracement of the move we analyzed on the Daily.
Notice how when prices were surging higher, price stalled at that zone before working through it, and then exploding higher for a strong breakout into the red zone. It was almost a slow motion move as buyers pushed prices through resistance at the confluent spot, affording numerous opportunities to join in on the trend.
Also notice here, however, how prices cut through the 50% marker before bottoming out. Prices initially broke through that level without even stopping, but then pulled back to find resistance over two separate occasions before falling further. This is also a signal that can be used.
The key is finding price inflections at key areas on the chart so that traders can then look for asymmetric bets, risking a little to try to make a lot.