Fibonacci Retracement & Extension
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To find possible correction levels in a trend when price corrects or pulls back
The extent an impulsive wave/swing can go till
Why is that Fibonacci levels work?
Some argue that it is due to the core mathematical principles underpinning Fibonacci numbers and their relation to the natural geometrical structures found throughout nature, whilst others argue it is simply due to crowd mentality and the fact that as so many traders watch these levels and anticipate their response, they have become a kind of “self-fulfilling prophecy”.
So which is true? well, probably a bit of both, but the important point is that we don’t need to know for certain why it is they work just that they tend to.
A key consideration here is that we can never know for certain which Fibonacci level will yield a reversal, or indeed if any will, but they are powerful levels to identify and monitor because of how often they tend to work. It is certainly not advisable to simply trade the level expecting a reversal but where we can find Fibonacci levels that line up around key structural points, such as support/resistance formed from previous highs and lows, this increases the chance of the level holding.
Fibonacci Retracements
It helps to know how much the price is retraced or pulled back or corrected after an impulsive move. So from an absolute swing high to an absolute swing low, we know that the price moved down in an impulsive wave (as shown in the picture below) before it moved up within that high and low. The retraced move (the move up in this case) can retrace up to a Fibonacci level which is also the percentage of retracement of the impulsive move down. for eg. if it retraced 61% of the move up, it is at the Fibonacci retracement level of 61%.
Retracement Levels: Usually price corrects up to the Fibonacci Retracement levels the common ones are 38%, 50%, 61% and 78%.
Whereas Fibonacci retracement measures a move to find levels to look for a price to retrace into, Fibonacci expansion measures a move to project levels in the direction of the primary move that price is likely to move into in future.
The extension, therefore, is numbered with respect to the Impulsive wave. The Fibonacci extension tool has 3 points instead of 2. Using the bullish example from the picture below, we measure first from the swing low to the swing high and then also to the retracement low.
Extension Levels: Common extension levels used for profit targets are 127%, 138%, 161%, 261%.
Retracements are always drawn of the Impulsive waves.
Check to learn how to use the Fibonacci Retracement and Extension tools in the Trading Terminal.
