Crypto Investing
29 Nov 2021

What is Fibonacci Retracement and How to Use it as an Indicator?

Ananda Banerjee

Technical traders use Fibonacci Retracement quite extensively. They exhibit key numbers discovered in the 13th century by mathematician Leonardo Fibonacci. Fibonacci’s numerical sequence is the logic behind this retracement tool, which ultimately are represented as ratios.

A Fibonacci retracement is calculated in technical analysis by selecting two extreme points on a chart and dividing the vertical distance by the important Fibonacci ratios of 23.6 %, 38.2 %, 50 %, 61.8 %, and 100 %. So, in this post, we’ll try to figure out what Fibonacci retracement is and how to apply it.

Key takeaways

  • Fibonacci retracement is a crucial instrument for technical analysis that analyses the price charts to identify likely support and resistance areas using horizontal lines and percentage values.
  • Important Ratios are are 23.6 %, 38.2 %, 50 %, 61.8 %, and 100 %.
  • Fib calculators are used in measuring retracement levels.
  • Fibonacci levels can be used during uptrend and downtrend and also during a sideways market.
  • These indicators, with other indicators, can perform more accurately.

Important Points about Fibonacci Retracement

Fib Retracement points are crucial tools in the technical analysis of cryptocurrencies.
They analyze price charts to identify likely support and resistance areas using horizontal lines and percentage values.
They give more accurate results when used along with other indicators.
They’re created by taking two extreme points on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%.
F.S. is a series of endless numbers where each number is a sum of the preceding two numbers. 

FS: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144

Fibonacci Retracement vs Fibonacci Extensions 

A Fibonacci retracement is a crucial instrument for technical analysis that analyses the price charts to identify likely support and resistance areas using horizontal lines and percentage values. It is known to be quite beneficial in the gold, silver, equities, currency, and crypto markets.

In this figure, the price has jumped from $15 to $30, and the retracement from the low point ($15) to the highest point ($30) is 50% at $23. That $23 comeback is called a Fibonacci retracement level (here, it’s 50%).

Fibonacci Retracement

Source: Fidelity.com

Since these levels are drawn between any two major price points, such as a high and a low, the indicator is considered valuable. The indicator will generate the levels between those two points.

Real-Time Examples

For example, assume the price of crypto climbs from $100 to $200. In this scenario, the retracement would be $176.4($200 – ($100 x 0.236) = $176.4), which is a 23.6% Fibonacci figure. Fibonacci numbers may be seen all across nature. Fibonacci calculators are used in calculating these levels.

Everything about Fib Retracement

Similarly, the Fibonacci extension is a tool used by traders to set profit targets. In simple words, this tool helps to predict the market by providing certain levels that the market may go. Extension levels are the potential locations for price reversal. Fibonacci extension levels that are commonly used include 61.8 %, 100 %, 161.8 %, 200 percent, and 261.8 %.

 

Fib retracement example

Source: DailyFx

Imagine that the Fibonacci retracement level is at $94.80. This is drawn from the highest point ( Point B) to the lowest point (Point A), and therefore the Fibonacci extension level is obtained at $94.80 (Which is a 100% extension level).

If the price passes through one extension level, it may proceed to the next. Although the price may not halt or reverse at the level, the area surrounding it may be significant. For example, the price may go close past the 1.618 level before reversing direction.

If a trader is bullish on crypto and it makes a new high, the trader can utilize the Fibonacci extension levels to forecast where the crypto may go. The same is true for a short trader. Fibonacci extension levels may be computed to provide traders with possible profit targets. So now, let’s try to understand how Fibonacci ratios work.

How do Fibonacci Ratios Work?

Let’s first examine the Fibonacci number series.

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 are all Fibonacci numbers. This series is endless since each term is simply the sum of the two preceding terms. One notable feature of this numerical series is that each number is 1.618 times larger than the previous one. This common link between all numbers in the series is the basis for technical traders’ retracement levels.

  • To find the crucial Fibonacci ratio of 61.8 percent, divide one number by the next. For example, 21/34 = 0.6176, and 55/89 = 0.61798.
  • The 38.2 percent ratio is found by dividing an integer by the number two places to the right. For example, 55 /144 equals 0.38194.
  • To find the 23.6 percent ratio, divide one number by the number three places to the right. For example, 8/34 = 0.23529.

All of these computations are possible with the aid of a Fibonacci calculator.

The Formula behind Fibonacci Retracement Levels 

There are no formulae for Fibonacci retracement levels. The user selects two points when these indicators are added to a chart. Following the selection of those two spots, the lines are created at percentages of that change.

Assume the price climbs from $10 to $15, and these two price levels are the points from which the retracement indication is drawn. The 23.6 % level will then be at $13.82 ($15 – ($5 x 0.236) = $13.82). The 50% mark will be $12.50 ($15 – ($5 x 0.5) = $12.50). You can simply use a Fibonacci calculator to get accurate results.

How to draw Fibonacci retracement levels?

Drawing Fibonacci retracement levels is a straightforward three-step procedure:

During an uptrend

Fibonacci retracement downtrend

  • First, determine the market’s direction: Uptrend 
  • Then use the Fibonacci retracement tool by dragging it from the bottom and moving it to the right top.
  • Finally, mark possible support levels: 0.236, 0.382, and 0.618.

During Downtrend

fibonacci retracement uptrend

  • Determine the market’s direction: downtrend
  • Use the Fibonacci retracement tool by dragging from the top to the right bottom.
  • Mark possible resistance levels: 0.236, 0.382, and 0.618.

Example of how you can use Fibonacci Retracement Levels

Consider a circumstance in which you intended to acquire specific crypto but were unable to do so due to a sudden increase in its price. In such a case, the most logical course of action would be to wait for a pullback (retracement). Fibonacci retracement levels such as 61.8 %, 38.2 %, and 23.6 % serve as possible levels for crypto prices to come back.

You can detect these retracement levels by charting the Fibonacci retracement levels and therefore position yourself for an opportunity to enter the trade. Please keep in mind that the Fibonacci retracement should be used as a confirmation tool, just like any other indication.

Further, it is advisable to use other indicators for confirmation. Don’t fall into the trap of believing that since a price has hit a Fibonacci level, the market will automatically reverse.

For a stronger indication, combine Fibonacci levels with Candlestick patterns, Oscillators, and Indicators. A combination of indicators can help you make informed decisions.

Pros and Cons of Fibonacci Trading

The Fibonacci retracement is used at the option of the trader. Fibonacci retracement levels can be used in various ways. Price activity may reflect the fact that traders are all watching and utilizing the same Fibonacci ratios or other technical indicators.

Any Fibonacci tool’s basic concept is a numerical calculation that is not supported by any logical proof. The Fibonacci sequence’s ratios, numbers, sequences, and formulae are simply the result of a mathematical process. It doesn’t mean that Fibonacci trading is necessarily untrustworthy. However, it can prove to be useless for traders who wish to grasp the reasoning behind a strategy.

Furthermore, a Fibonacci retracement technique can only indicate potential corrections, reversals, or countertrend rebounds. This method has difficulty confirming other indications and does not offer clear signals.

Final thoughts

Fibonacci levels are found everywhere in the world. These are fascinating computations used in Fibonacci trading. The Fibonacci retracement is an important trading technique for identifying chart patterns. More the number of market participants better the working of the Fibonacci indicator. There are a lot of variations that can be applied with Fibonacci extension levels, and at the same time, it is necessary to be aware of its limitations.

FAQs Fibonacci Retracement:

  • How do you use Fibonacci retracement?

Fibonacci retracement can be used as a drag and drop tool. You just have to select the tool and draw the levels as per the market trends mentioned in this article.

  • Is Fibonacci retracement a good strategy?

For accurate results, it is advisable to use Fibonacci retracement with other indicators or oscillators.

  • What time frame is best for Fibonacci retracement? 

If you are a long-term trader, you may apply this to a daily or weekly chart. Similarly, if you are a short-term trader, use this on 30/60 minutes charts for the optimum results.

  • What is the success rate of Fibonacci retracement? 

Firstly, it is entirely dependent on how you utilize it. Also, it is advisable to backtest this indicator before using it in real-time trading. If all the things are done correctly, then an 80% success rate can be achieved with the Fibonacci indicator.

Is fibonacci retracement your thing? Download the app, select crypto players, and implement strategies to start trading right away.

P.S.: KuberVerse is an educational initiative. Anything expressed here directly or indirectly is not investment advice. And we ask you to do your own research before investing.

 

 

 

 

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Ananda Banerjee

Content Writer

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