Know how to trade using Fibonacci: If you have been investing in the stock market on a regular basis, you must have heard about fundamental and technical analysis. These are the 2 methods on the basis of which investors and traders make their respective investing decisions.
Like in fundamental analysis, there are different tools in technical analysis which help in identifying momentum in the stock price and relevant entry and exit points.
Market technicians spend most of their time evaluating strong support and resistance levels, so that they can capitalize and exploit as and when the opportunity occurs.
While there are several techniques in technical analysis, the Fibonacci tool is the most widely used. Let’s have a quick look at the use of Fibonacci, and how traders and investors can benefit from it.
Fibonacci when used in trading, means a tool that helps in measuring the size of the price move and it helps in placing horizontal support and resistance levels on the chart.
Traders call these levels “Fibonacci levels”, and these levels assist them in making trading decisions. This article tries to explain How to trade using Fibonacci, so let’s get started.
How to Trade Using Fibonacci?
From the work of renowned mathematician Leonardo Fibonacci, market technicians have a Fibonacci sequence of numbers and the Fibonacci golden ratio. The Fibonacci sequence represents a series of numbers in which the next number is actually the sum of 2 preceding numbers.
Let’s understand this with the help of an example. Fibonacci sequence will run something like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 and so on. When stock price moves, the beginning, and end of that move is clearly visible and can be identified. With the help of the Fibonacci tool, technical analysts measure the distance of that move.
The fibonacci tool will place Fibonacci retracement and extension levels automatically. Actual calculations of these levels stem from numbers in the Fibonacci sequence or percentage difference between them.
At the time of measuring a downtrend, you need to apply this tool at the very beginning of the move to the end. Please note that it should be applied from left to right. When you measure an upward move, this tool needs to be applied from the bottom and end at the top. Again, it should go from left to right.
What After You Have Applied the Fibonacci Tool?
Once you have applied the Fibonacci tool, Fibonacci levels between the start and the end of the move are placed automatically. These levels are known as retracement levels. Fibonacci retracement levels depict retracement reversal points with accuracy.
Another added advantage of retracement levels is that they can be applied to all time horizons i.e., day trading and long-term investing.
Fibonacci levels are visible as percentages of the total move. So, a level that gets placed halfway between the start and the end of the move is represented as a 50% retracement level. In simple terms, it depicts that if the price retraces to the 50% level, it means it has retraced halfway back.
Now, depending on the trend, market technicians can assume support or resistance levels. Therefore, it can be inferred that retracement levels help in predicting how far the pullback can be. The most commonly used retracement levels are 38.2%, 50%, and 61.8%. These are the levels that the price could retrace back to. There are other retracement levels too which work well.
Fibonacci Retracement Levels Can Give Relevant Entry Points
If the Fibonacci tool is applied to an uptrend, and 38.2%, 50%, and 61.8% retracement levels get placed in between the start and end of the move, it can help in identifying potential entry points. This is because these are the levels to which the price can retrace back to.
To make profits from the trading strategy, market technicians try and enter at each retracement level. Then they place a stop loss on the other side of the Fibonacci level. In case the stop loss gets hit, they enter again at the next level. This can be carried on until the price moves in favor of the analyst.
The Fibonacci tool can also help in projecting extension levels. These levels show where the price can ultimately go to. Technical analysts use Fibonacci extensions for booking profits or for counter-trend entries.
Most common extension levels include 138.2% and 161.8% levels. There are many other extension levels too that are being regularly used by traders. In an uptrend, traders usually make a long entry at the retracement level, and then they exit at an extension level.
Before jumping to using Fibonacci lines, please note that Fibonacci lines help in giving confirmations. This indicator delivers the best results when used along with other technical analysis tools like trendlines, volume indicators, etc.
Trade signal tends to be strong when confirmed with a greater number of confirming indicators. That’s all for the post on “How to trade using Fibonacci?”, Hope you liked it. Happy Trading!
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