Commander in Pips: This is our final lesson about Fibonacci. Today we will repeat the major terms about it, just to sum up knowledge. But in the beginning I want to note, that if you are really become fascinated with Fibonacci, then I strongly recommend you to read Joe DiNapoli’s book “Trading with DiNapoli levels”. This book teaches advanced techniques of applying Fibonacci tools – such as retracement as extensions.
1. Fibonacci retracement levels are: 0.236; 0.382; 0.5; 0.618; 0.786; 0.886; 1.0. The major amongst them are 0.382; 0.50 and 0.618.
2. Retracement levels always stand inside the initial market swing;
3. Traders use Fibonacci retracement levels as potential support or resistance. The major rules for using retracement are as follows: “Buying deeps or selling rallies”.
- “Buy deeps” rule applies during a market up thrust and means that we should buy from one of the retracement levels. In this case Fibonacci retracement levels act like support levels;
- “Sell rallies” rule applies during a market down thrust and means that we should sell from one of retracement levels. In this case Fibonacci retracement levels act like resistance levels.
4. If you do not have a software that calculates retracement automatically, you can apply the formulas t calculate Fib levels yourself:
- for retracement from Up thrust: Swing high - (Swing high – Swing low)*ratio;
- for retracement from Down thrust: Swing low + (Swing high - Swing low)*ratio;
5. Although the most time retracement level are used as an area for potential entries into the market, you also may use them as an area to take profit. Specifically, you can use retracement levels of higher time frames as a potential areas to take your profit;
6. Multiple retracement levels from different swings could create Confluence retracement areas. These areas are stronger than just single level and could typically be formed only with 0.382 with 0.618 Fib levels;
7. Major Fibonacci extensions ratios are: 0.618; 1.0; 1.272; 1.618; 2.0; 2.618. But mostly applicable the 0.618; 1.0; 1.272; 1.618. 1.0 extension is very important.
8. Extension targets or as they called sometimes Expansions, are used as a potential levels for taking profits;
9. To calculate an extension target you may apply the formula:
Extension = (X-A)*ratio + B, where X-A is the initial swing and B is the retracement point;
10. The “B” point should stand inside X-A swing and all upward/downward extension targets have to be above/below “B” point;
11. Coincidence of extension target with any Fib retracement level or Confluence area creates a stronger level and is called “Agreement”;
12. Sometimes, extensions could be used for support/resistance estimation. For that purpose it’s allows us to have a “B” point slightly outside initial swing “X-A”.
13. Although the Fibonacci tool is a type of leading indicator, because it shows potential support or resistance levels ahead the market – it doesn’t tell us much how the market will respond on these levels and which levels will hold. Yes, we’ve said that depending on retracement depth we can judge much about the market’s strength, but this is not enough.
It means that we should apply Fibonacci tools only in a context of a potential trade and in combination with other tools. Now we’re already acquainted with support/resistance lines, trends and candlestick patterns that can be used with Fibonacci. But later we will learn more and study how to create a solid trading plan that will involve all the major tools.