Fibonacci Retracement: Technical Analysis Guide

February 9, 2024
Back to Articles

Explore the power of Fibonacci retracement in technical analysis.

Discover how this tool can enhance your trading strategies.

The Basics Of Technical Analysis

Technical analysis is arguably the most critical tool in financial markets. Used by investment houses and retail traders for centuries, its origins can be seen as far back as the 18th Century when rice traders in Japan would set up price charts and use technical indicators to forecast price movements and analyze the market.

The traders would use what is called a candlestick chart where, if one bar was engulfing the previous bar, this was seen to be either a bullish or bearish signal depending on whether the price of the asset was engulfing to the upside or the downside, meaning that prices may be more likely to increase or decrease in value because of this price action. Horizontal lines are often added to the chart to indicate support and resistance levels, which can help traders make informed decisions about when to buy or sell. Another tool traders use is the moving average, which helps smooth out price fluctuations and identify trends.

Candlestick trading is still very much used today to predict where future prices may be heading. However, another popular type of technical analysis that is regularly used today is Fibonacci sequences which traders would use not just to predict where prices may be heading in the future but also to identify crucial points of support and resistance on a chart and is used as a tool to set up stop loss and limit orders and it is this form of technical analysis that is going to be the subject of my article today.

The Origins of Fibonacci

Although the Fibonacci sequence can be traced back to ancient Indian literature, it was first talked about in the 13th Century by Leonardo Bonacci of Pisa, an Italian mathematician, who wrote a composition of mathematical calculations in his book called 'Liba Abaci' and that alluded to the Leonardo Fibonacci numerical sequence. By the early 16th Century, there was the first mention of what he is known today, but it wasn't until the 19th Century that Bonacci was given the nickname 'Fibonacci'.

The Fibonacci Sequence Explained

Fibonacci is a sequence of numbers where each is the total sum of the previous two numbers. When the first number in the sequence is 0, and the following number in the sequence is 1, the first number(0) would be added to the second number(1) then the answer to the calculation would = 1, e.g. 0 + 1 = 1

Following this, the following number in the sequence would be 1, which is then added to the next number, which would also be 1, e.g. 1 + 1 = 2. The Fibonacci series is a mathematical sequence where each number is the sum of the two preceding numbers, starting from 0 and 1.

Carrying on this mathematical formula would give you the Fibonacci sequence, which follows as 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89,144, 233, and so on. This lies the basis of Fibonacci within technical analysis within the financial markets.

Fibonacci Retracement Ratios Explained

Fibonacci ratios come from the Fibonacci sequence, but instead of adding two consecutive numbers to each other, you will divide numbers either to the left or to the right of the first number you are counting from, depending on how far you wish to calculate. These ratios form the basis of retracement trading, including percentage retracements, in the financial markets. One of the most popular tools used in retracement trading is the fibonacci retracement tool. I will use the most common ratios in these examples to show you where this can be applied to trading. I will use the number 21 for this particular calculation.

a) The Fibonacci number 21 is divided by the Fibonacci number 89(3 places in front) = 0.234

b) The Fibonacci number 21 is divided by the Fibonacci number 55 (2 places in front) = 0.382

C) The Fibonacci number 21 is divided by the Fibonacci number 34 (1 place in front) = 0.618, a key ratio used in Elliott Wave Theory.

d) The Fibonacci number 21 is divided by the Fibonacci number 13 (1 place before) = 1.618

e) The Fibonacci number 21 is divided by the Fibonacci number 8 (2 places before) = 2.618

The most important number on this list is 1.618, the golden ratio or golden mean. It must be pointed out that 0.5 is not a Fibonacci number, but as it is the halfway point, the 50% mark between any swing low and swing high, it has to be of particular importance as it signifies the middle point of any bull and bear price action. Understanding chart patterns is crucial to identifying these swing lows and highs and making informed trading decisions.

Using these Fibonacci ratios, and not necessarily starting at a fib number, but starting on any two particular places on a chart, we can calculate possible future support and resistance points, including potential reversal points. These can include retracement levels; possible future bounces and turning points in a market, price spikes off support and resistance on any chart and on all timeframes and heading forward, Fibonacci extensions, and time cycles, including Fibonacci retracement lines and price patterns, which I will come to later. Traders and investors, especially technical traders, can use these Fibonacci sequences and ratios for breakout trading and can help you enter any particular asset, combining stop loss and trailing stop strategies. Fibonacci technical analysis, including the elliott wave principle, could arguably be the complete all-in-one trading strategy.

The Golden Ratio, Fibonacci Cycles, and Cases in History

Fibonacci sequences can be seen throughout history in science, nature, and the discovered universe. As mentioned previously, the most important of all these calculations is the 1.618, the Golden Ratio. These Golden Ratios can be found in the branching patterns of trees and also in leaves, where each stem is positioned at a particular angle compared to the previous stem—the growth curve of a sea shell increases by the golden ratio of 1.618. Within the animal kingdom, certain animals will produce in set monthly cycles using Fibonacci numbers. Even in our bodies, Fibonacci cycles can be found in our DNA and at a molecular level. The distance between the planets in our solar system is close to the golden ratio of 1.618. Some species on our planet follow Fibonacci sequences in their birth rate.

In construction, many historical instances show a correlation between how Egyptians built the pyramids, Fibonacci spirals, and the Golden Ratio. From the Parthenon in Greece to the Taj Mahal in India, ancient buildings and Monoliths were made using the Golden Ratio.

This is why Fibonacci sequences are regarded as much more than mythical magic and have a much broader place within our lives and the whole solar system. For this very reason, traders and investors worldwide will use Fibonacci sequences, time cycles, and the Golden Ratio to predict turns in the market that helps to make their decisions to enter and exit all assets across the financial spectrum.

Fibonacci Ratio Examples In Cryptocurrency Trading

Firstly, it's vital to understand that Fibonacci levels can be taken from any arbitrary points on a chart and on any given timeframe. It is a matter of preference which timeframe works better for each individual. Backtesting can often help as it can show previous examples of Fib levels reoccurring on the same asset, thereby improving your odds of those turning points happening again on the same chart.

On the BTCUSD chart below, I have specifically chosen the November 2022 double bottom. I have taken my Fibonacci tool and started the first point from the November swing low at 15479, this being figure (1). I have then dragged my Fib tool up to the December swing high of 18373.00. Once I do this, the fib tool will automatically draw on the significant fib numbers between the swing low and the swing high. These Fib numbers will stay on the chart and help me find possible turning points.

As you can see on the next chart, as we zone in, the price did retrace, right back down to the 0.618 level; it then spiked below it, showed support, and headed back upwards. This is a perfect example of Fibonacci at its very best.

‌Here is another example on the adausdt weekly chart below. Again, I've taken 2 points, from a swing low to a swing high; from this point, the Fibonacci tool has drawn on the relevant fib numbers. Yet again, the price has come down to 0.618, spiked below, and then moved upwards again.

‌Here's one more example, this time on a monthly chart to show exactly how powerful Fibonacci retracements can be. When Polkadot got listed in August 2020, the price was driven up along with the rest of the cryptocurrency markets, finally reaching an interim high of $49.78 in May 2021. However, from that point in time, prices retraced dramatically over the next three months. You may have been forgiven for thinking that the top was in for the year but using your Fib retracement tool, starting at the lows of $2.00 in August 2020 and dragging the tool up to the May 2021 highs, and then looking at the significant fib levels, you can see that price found a low almost at the maximum 0.786 retracement level. Not just this, but the chart created a glorious monthly pin bar. From this point, the price didn't look back and went on to make all-time highs before finally reaching its long-term top.

Fibonacci Extension Example

A Fibonacci extension finds potential turning points within a trend beyond the swing high and low I previously showed to find retracements. Where the Fibonacci retracements will show moments of possible support and resistance within a pullback, the fib extension will try and predict those turning points after the zero line and when the other trend is in—in simple terms, finding price levels to take potential profits once the trend is in place.

For simplicity, I've used the same btcusd chart I used on the first Fibonacci retracement example. The chart below shows the 3 points marked out on this particular asset. The first arrow is the BTC low, the second arrow is the short-term temporary swing high that followed the lows, and the last arrow shown is the retracement and secondary low that formed the double bottom.

‌Although there are a few ways to use Fibonacci extensions, I have used the popular Fib Based Trend Extension tool on most charting platforms. On the following chart, my fib extension tool starts from the November 2022 low. Once I have done this, I have pulled the extension tool up to the December swing high. This would have been the highest point before the price started retracing to form the double bottom. Finally, I have pulled the fib tool down to the 3rd point, marked by the last black arrow on the chart. As you can see, the Fibonacci extension tool has drawn in the fib levels that I have put down in the chart settings, starting from the December secondary low marked by the blue arrow, then moving upwards in Fibonacci increments.

‌The following example clearly showing the Golden Ratio of 1.618 working at its glorious best, marked by the blue arrows. Price first found resistance at the 0.236 level and then rocketed straight up to the Golden Ratio and showed resistance, pulled back slightly, and then continued its uptrend. Remarkably, the price carried on right up to the 2.618 extension and found resistance there as well. Obviously, at those times, there would have been no way of predicting price would have carried on going up or retracing, but seeing the price stall at these all-important levels, would have been an indication that the price may have stalled and given a chance for a potential profit take.

‌Fibonacci Time Cycles and Their History

The Fibonacci time cycle is one crucial strategy that tends to get left behind in Fibonacci technical analysis. This is a method of finding future price turning points using Fibonacci trading sequences. These points can be started from anywhere on the chart from the past, present, and future by counting either backward or forwards in time and may help the trader and investor predict where the price may flip.

I believe Fibonacci time cycles were best put to use by William Delbert Gann, famously known in trading circles as W. D. Gann, in the early 20th Century. Gann used a variety of strategies to predict market turning points in both price and time, from geometric mathematics and market psychology right the way through to astrology. Still, his use of Fibonacci sequences and ratios made him most famous. Gann believed that by using a multitude of confluence, there was every chance of him predicting many turns in the market. As a result, there are many instances of him creating large profits in many trades across a board of assets. A whole article can be written on the success of W D Gann, but for the sake of time, I will leave this for another day.

Forward Count Fibonacci Time Cycles Example

The best way to explain how a Fibonacci Time Cycle works is by showing an example on a chart using Fibonacci sequences. Below is a straightforward example of an Ethereum chart of forward cycle analysis. My starting place is the arrow shown by the number 1. I then counted forward from this point and placed arrows on all Fibonacci numbers that had created a trend change, whether a minor or a major one forming a significant swing high or low.

The fib numbers 13, 21, 34, and 89 all show trend changes. The 13 and 21 fibs produced significant swing highs and lows, the 34 and 89 showed small trend changes, and what would have been the 55, which I haven't placed on the chart, showed nothing at all. The premise is that the more fib numbers that produce trend changes in the past significantly increase the odds of a further trend change on a fib number in the future. Like all technical analysis, the higher the time frame and the more significant the trend change that has previously happened increases the likelihood of a more substantial trend change.

Backwards Count Fibonacci Time Cycles

The Bnbbtc weekly chart below is an excellent example of how to start a Fibonacci count from the following week of where we currently are sitting and count back all the significant fib numbers, marking out each one and then observing if there were any trend changes on that particular day. Again, the premise is that if we had significant trend changes on most of the fib days, the odds increase on a trend changes the following week.

‌It's easy to see, by doing this backward count, that the numbers 5, 8, 13, and 34, show a trend change, so we can look to the next week and make a decision on whether we believe that will also produce a trend change in the future based on the number of times previously price managed to change direction.

Fibonacci Time Cycles and Ratio Convergence

When you calculate that you may be dealing with a possible trend change on any particular future candle based on a Fibonacci count back, in combination with a potential bounce off a Fibonacci retracement level, you may very well be dealing with the significant confluence on your chart, and this could increase the chances of a further trend change on that particular day, week or even month. For example, the weekly RSR chart below clearly shows the price bouncing off the 0.382 Fib level and, simultaneously, being the 1st candle on a weekly countback that hit several fib numbers—a perfect example of Fibonacci confluence. Once you noticed that there were trend changes on the 5th, 8th, 13th, and 21st day, you would be confident that a possible trend would come up shortly on the day marked number 1.

‌Alternate Fibonacci Sequences

An alternate Fibonacci count, or a Lucas count, is where the Fibonacci sequence is still used, but the numbers have a different starting point. Instead of the standard 0, 1, 1, 2, 3 Fibonacci sequence, the starting point will be 2, 1, 3, 4, 7. Acting the same as the standard Fibonacci sequence, where a number is the sum of the two previous numbers, the Lucas count will still be the same, but because it has a different starting point, the whole numerical sequence will have an alternative count, this time being 2, 1, 3, 4, 7, 11, 18, 29, 47, 76, 123, 199 and so and so forth. By using this alternative count, we can still possibly find Fibonacci symmetry.

Back to Articles
Other Articles