In the last installment of the trading training series we talk to you about the Koncorde indicator. This new-age indicator allowed us to detect institutional and retail movements through patterns. Without a doubt, an indicator that we must learn to interpret to anticipate possible movements that may affect our portfolio. And speaking of good tools, it took me a while to show you one of the favorites in the world of trading. So in today's trading training we will talk to you about the Fibonacci retracement tool and how we can take advantage of it.
What is Fibonacci retracement?​​
This is one of the most important tools that we are going to cover in the series of trading training articles. Originally, Fibonacci is a representation of the golden ratio, it is basically the infinite sequence of natural numbers. It was first described in Europe by Leonardo of Pisa, or better known as Fibonacci. The sequence of these numbers begins with the numbers 0 and 1, from then on each term is the sum of the previous two.
Representation of the golden ratio. Source: Photographer's Blog.
If otherwise we divide each number with the previous one, we obtain the sequence that approximates the golden number phi, equal to 1,618. This tool comes equipped with many variables (retracement, extension, speed resistance fan, time zone, time zone, cycles, spiral, arc, wedge, channel) but the most important or useful one is the Fibonacci Retracement given that it indicates support and resistance levels on the chart defined from a maximum and a minimum.
How is Fibonacci retracement measured?​​
As we explained in the previous paragraph, Fibonacci retracement is measured with the golden ratio. In the charting platforms it is created automatically for us using the Fibonacci retracement tool. Firstly, from a maximum point (or minimum, we will see later) it can help us identify possible pullbacks when it breaks resistances or supports. It is recommended not to enter the market if these have not been carried out.
Appearance of the Fibonacci retracement tool applied to an asset. Source: Tradingview.
It is better to work with logarithmic scales in larger time ranges, since they give us more accurate signals. Additionally, it is a tool that we can use in two temporalities simultaneously to detect the key areas of each time frame. The usual configuration of the tool has the following parameters seen in the graph above, although the colors shown may vary according to the taste of each trader. So, now that we have seen how it works and how it is measured, let's discover certain patterns of behavior.
How can we interpret Fibonacci retracement patterns?
As we have just defined this tool, it allows us to delimit support and resistance levels in the price of an asset from a minimum and maximum point (or vice versa). From there everything is fine, we see that we have floors and ceilings in the graph that delimit important areas for us. Now comes, as we have explained in other trading training articles, when we get to work learning certain patterns to take advantage of in our operations. We recommend combining the signals of this tool with other indicators or tools (such as guidelines). Let's look at some of the most effective Fibonacci retracement patterns:
Retracement to 38,2% from minimum/maximum
This is the quintessential Fibonacci retracement tool pattern. Without a doubt one of the most effective ones due to its easy understanding and detection. This pattern is based on the observation of a maximum applying the tool. We trace the path from highs to lows (or vice versa) and draw a guideline that can delimit the possible path of the price. It is recommended to observe the price when it breaks the guideline and wait for it to pull back to the guideline. At that point, the price will most likely head towards the 38,2% retracement level.
Retracement to 38,2% from lows/highs. Source: Tradingview.
Retracement to 61,8% from lows/highs
The pattern that we will see below is similar to the one we just showed you in the previous paragraph. Mainly it may depend on the first, given that the retracement towards the 61,8% level can occur in circumstances that strongly support a movement in that direction, or that arrives a little later from the 38,2% level.
Retracement to 61,8% from lows/highs. Source: Tradingview.
The thin red line, 50%
This pattern is not as popular as the others mentioned above. But that does not mean that they are not useful, since the red line in the middle delimits half of the recoil path. This means that the stops or breaks that the price makes in this area will help us determine if the breakout movement will continue or if it will instead turn around.
The thin red line, 50%. Source: Tradingview.
V-turn movement from 61,8% to 38,2%
This is one of the most curious patterns that we can observe within this trading formation. As if it were a recovery movement of an economy (recoveries in V, L, U, etc...), we can also identify this formation in this tool. The best thing is that this type of V reversal pattern usually occurs frequently when an asset stays in a range between the levels of 61,8% and 38,2%.
V-turn movement from 61,8% to 38,2%.​ Source: Tradingview.
Fibonacci Extension
One of the patterns in this series that is also quite effective. Of course, one of which must first detect the price trend to avoid making mistakes. This pattern is based on the observation of an asset that has just completed the journey of a retracement from highs to lows. The moment it breaks the upper (or lower) level, it usually makes an upward movement to then support itself at the level it has just broken. At that point, the asset's price may be preparing to implode towards the 1,618% level.
Fibonacci Extension at 1,618%. Source: Tradingview
Conclusions from this Fibonacci retracement trading training
After finishing this trading training on the Fibonacci retracement tool, we have seen the usefulness it offers to our operations. Firstly, it is wonderful that a sequence of numbers is so present in every part of the world's daily life, from the formation of company logos, to the design of buildings, to nature itself making its way with that sequence of numbers.
The Fibonacci sequence present everywhere. Source: Quora.
At the same time, we have also seen how we can interpret some of the behavioral patterns. These allow us to visualize price structures that tend to be fulfilled with a high probability. It should be noted, as we mentioned at the beginning of the trading training, that there are other tools based on Fibonacci, but this is the most universally used by traders.