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Trading with Fibonacci Ratios

13 Jun Posted by in Fibonacci Ratios | Comments
Trading with Fibonacci Ratios
 

 

Fibonacci Ratios: Retracements or Extensions?

One of the most powerful set of tools we can use with tremendous accuracy and reliability are the Fibonacci ratios. These ratios are part of a class of ancient mathematical phenomenon known as sacred geometry. Fibonacci patterns are found in all things natural, including all freely traded markets.

Many traders have had some exposure to Fibonacci calculations in their trading. But very few realize just how awesome they can help pinpoint turns in the market when used properly, whether you’re a day trader, swing trader or position trader. But are they really reliable? Are all Fibonacci ratios created equal?

There are basically two ways of applying them: First as retracements and the other as extensions. So what’s the difference?

First let’s talk about the different retracement levels. Most traders are familiar with retracements such as the 38.6%, 61.8%, or 78.6% retracements. But among these, the 78.6% is the deepest and therefore most extreme retracements, making it more trustworthy than the other retracements. Why is this so? As price action retraces, first it will address the 38.6% level. However, we do not know if price will turn from there or will keep retracing to the next level which is the 61.8%. After hitting the 61.8% level, we should still suspect price may keep going to the last level, the 78.6%. This final level is where the market “retests” a high or low. A trader can use a stop loss one tick above/below the pivot in case it blows through and is no longer a retracement. This makes the 78.6% level a low risk entry since there is no other significant retracement level beyond it. And the stop loss is only a short distance away. See chart 1.

In picking tops and bottoms, I’ve discovered that Fibonacci extensions are superior to retracements, especially extreme extensions. I find the 261.8% extension particular useful in pinpointing a top or bottom. This tool  can also be used as a target where you take profits. I mainly use the 261.8% extension on double tops/bottoms as well as measured moves. See chart 2.

Extensions must be used in multiple layers to confirm a possible turning point. Many Fib numbers influencing at a zone will more likely turn price around as they reinforce one another. That’s why we average Fib numbers.

When a group of Fib extensions cluster at one of the three major retracement levels, then that particular retracement level may be where a high/low would occur with a less likelihood of price slipping to the next retracement level(s). That makes Fibonacci extensions a priority over retracements in terms of usefulness.

 

Please click on the charts below to make them larger.
June Gold Daily Chart 1

June Gold Daily Chart 1

 

June Gold  Daily Chart 2

June Gold Daily Chart 2

 

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