How to apply Fibonacci Retracement for IntraDay Trading

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Fibonacci Retracement Levels in Day Trading

Tool to Help Isolate When Pullbacks Could End

Moves in a trending direction are called impulses, and moves against a trend are called pullbacks. Fibonacci retracement levels highlight areas where a pullback can reverse and head back in the trending direction, making them helpful in confirming trend-trading entry points.

Origins of Fibonacci Levels

Fibonacci levels are derived from a number series that Italian mathematician Leonardo of Pisa—also known as Fibonacci—introduced to the west during the 13th century. The sequence starts like this:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89.

Each new number is the sum of the two numbers before it. As the sequence progresses, each number is approximately 61.8% of the next number, approximately 38.2% of the following number, and approximately 23.6% of the number after that. Subtract 23.6 from 100, and the result is 76.4.

These are Fibonacci retracement levels: 76.4, 61.8, 38.2, and 23.6.

The Relevance of the Sequence

What Fibonacci and scholars before him discovered is that this sequence is prevalent in nature in spiral shapes such as seashells, flowers, and even constellations. As a spiral grows outward, it does so at roughly the same rate as the percentages derived from the Fibonacci ratios.

Some believe these ratios extend beyond just shapes in nature and actually predict human behavior. The thinking is that people start to become uncomfortable with trends that cause changes to happen too rapidly and adjust their behavior to slow or reverse the trend.

According to this theory, if someone started out with $100 in his wallet, he would begin to slow his spending—or stop altogether—once he has spent about $61.80 and has only about $38.20 remaining.

How to Use Fibonacci Retracement Levels

When a stock is trending very strongly in one direction, the belief is that the pullback will amount to one of the percentages included within the Fibonacci retracement levels: 23.6, 38.2, 61.8, or 76.4. Some models also include 50%.

For example, if a stock jumps from $10 to $11, the pullback should be expected to be approximately 23 cents, 38 cents, 50 cents, 62 cents, or 76 cents. Early or late in trends, when a price is still gaining or losing steam, it is more typical to see retracements of a higher percentage.

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In this image, you’ll notice that between 61.8% and 38.2% there are two downward trends. This is an example of a Fibonacci retracement. The theory states that is a usual circumstance for stocks to trend in this manner because it is inherent in behavior to follow the sequence.

If your day trading strategy provides a short-sell signal in that price region, the Fibonacci level helps confirm the signal. The Fibonacci levels also point out price areas where you should be on high alert for trading opportunities.

Using a Fibonacci retracement tool is subjective. There are multiple price swings during a trading day, so not everyone will be connecting the same two points. The two points you connect may not be the two points others connect.

To compensate for this, draw retracement levels on all significant price waves, noting where there is a cluster of Fibonacci levels. This may indicate a price area of high importance.

Retracement Warnings

While useful, Fibonacci levels will not always pinpoint exact market turning points. They provide an estimated entry area but not an exact entry point. There is no guarantee the price will stop and reverse at a particular Fibonacci level, or at any of them.

If the price retraces 100% of the last price wave, the trend may be in question. If you use the Fibonacci retracement tool on very small price moves, it may not provide much insight. The levels will be so close together that almost every price level appears important.

Fibonacci retracements provide some areas of interest to watch on pullbacks. They can act as confirmation if you get a trade signal in the area of a Fibonacci level. Play around with Fibonacci retracement levels and apply them to your charts, and incorporate them if you find they help your trading.

Applying Fibonacci For Day Trading

Fibonacci Retracements are one of my favorite trading tools. The levels predicted by the tool are remarkably accurate and provide a great number of trading opportunities for me in my day to day routine. The thing is, Retracements are best used when dissecting a pronounced trend or sharp movement in stocks so they are not neccesarily the first thing you would turn to as a day trader. Why is this, simply because the day to day movement of any one asset, particularly a forex pair, is not that great. To understand let’s touch base quickly on what Fibonacci Retracements are. They are price levels determined by the Golden Ratio as laid out by the famed mathematician Fibonacci. The levels are percentages of a given price movement and are a useful as target areas for entry points. This tool is commonly available as a standard feature of most charting packages and comes with a few variations. Typically I would draw retracements on a chart of weekly or daily prices and then use those levels as potential areas for continuation or reversal. This method doesn’t provide a whole lot of entries for day traders but there are two methods of using Fibonacci that do.

Warning! Fibonacci Retracements are not signals, they are target areas where a signal may occur. Trading simply because price has reached a retracement level is not a sound method. Other signals indicating direction and duration are required before trades can be taken.

The Long Bar Method

Believe it or not I just made up the name of this strategy but the strategy itself is old, very old. The Long Bar Method targets specific days and is not for use on a day to day basis, unless of course the asset you are trading is volatile and makes a lot of wide swings. For this method to work you need to be patient and wait for a day when news, a technical break out or some other event causes the market to make a much larger than normal daily movement,say in the range of at least 1% or better. The bigger the day the better because you can expect the bounce back from that day to be stronger than on an average day. Once you have identified a day as a potentially good one draw (on the daily chart) a Fibonacci Retracement from the high to the low of the day; if it’s an up day from the low to the high, if a down day from the high to the low. Once this is done you can move down to a chart of hourly, 30 or 15 minutes as you prefer. Then as price bounces, or retraces, its way you can use the Fibonacci Lines as target areas for signals.

One note of warning, there is not always a snap back following a major market movement. If a rally is strong then there might be two or three days of upward movement or more before any kind of a snap back occurs. The same is true in a strong bear market. If this happen then you can draw your retracements for the entire movement, not just the one day.

This strategy works best when the market has made a major movement in the magnitude of 1% or more. Knee jerk reactions to bad news and speculative rallies on good news are two such events. Any time the market makes a significant movement a Fibonacci can be applied to that day or week.

The Day Wave Method

For this method I suggest that you use a chart with 30 or 60 minute candle sticks. This is a good time frame for watching the day to day swings in the market and for using Fibonacci Retracement. This method is also more useful for the average day trader as it can be used any day, not just after a strong market movement. To apply it, pull up a chart of 30 or 60 minute prices and then apply a Fibonacci to the most recent trough and peak. It does not matter if it is drawn from a peak to a bottom or vice versa as this is not a trend following technique. With this we are simply trying to find appropriate areas where a signal, any signal, can be found. Look at the chart below. I have drawn a Fib from the top of an intraday peak to the bottom of an intraday trough. The Fib tool provided several levels where signals might form. The bounce back was strong enough to blow through the first two retracement levels but gave an early signal at the 50% line. Then a second signal, a much stronger and tradable signal, forms from at a place where put trades could have been taken.

One note of warning, day to day market moves are highly susceptible to news and other near term market moving events. These can have an adverse affect on your trading if unprepared. Always check the economic and earnings calendar before entering a trade.

How To Trade With Fibonacci Numbers

What are Fibonacci numbers?

Leonardo Fibonacci introduced the Fibonacci numbers to Western mathematics in a 13th century book.

0, 1, 1, 2, 3, 5, 8, 13, 34, 55, 89, 144, …

Each number is the sum of the two numbers preceding it. Fibonacci numbers have unique properties and a special connection to the Golden Ratio.

Now, I will hand over to mathematician Arthur Benjamin, who is far more qualified to explain the magic of Fibonacci numbers.

Fibonacci in Trading

The magic of Fibonacci numbers is found in nature and biology. Designers, architects, and even computer scientists apply Fibonacci sequence in their work.

It is not surprising that, somewhere down the road, traders decided to give Fibonacci a chance. However, instead of using the Fibonacci numbers directly, traders focused on the Fibonacci ratios.

34/55 = 0.618 (Divide by next number)

34/89 = 0.382 (Divide by the next next number)

34/144 = 0.236 (Divide by the next next next number)

From these ratios, we got a whole host of Fibonacci trading techniques. These techniques have grown in application and complexity. And it is definitely possible to build a trading strategy completely around Fibonacci trading techniques.

Fibonacci Trading Techniques

There are several Fibonacci trading techniques. However, all Fibonacci trading techniques:

  • Anticipate price action, and not react to it;
  • Attempt to find support/resistance areas;
  • Are calculated based on a selected market swing.

The predictive nature of Fibonacci trading tools draws traders who are sick of lagging indicators.

For clarity, we applied the different Fibonacci tools below on the same bull swing from a weekly chart of SPY.

Fibonacci Retracements

This trading technique uses Fibonacci ratios to project price levels where we expect retracements to end.

Choose a market swing so that you can plot the retracement levels. The chosen market swing will define the range as shown in blue. Then, we apply the Fibonacci ratios within that range as shown by the black dotted lines.

In this example, price found some support at the 23.6% level but punched right through the 38.2% level. However, the golden ratio level (61.8%) provided solid support and stopped the retracement.

Fibonacci Fans

From Fibonacci retracements, we are able to draw Fibonacci fans which are a series of trend lines starting from the same point.

This is the same chart as above. We added the Fibonacci fans in red.

Draw a vertical line down from the peak of the chosen swing. Then, draw a trend line that passes through the lowest point of the swing, and the point where the vertical line and a retracement level intersect. There are three retracement levels, so there are three trend lines.

For down swings, apply the same logic.

These trend lines act as support and resistance as circled in black.

Fibonacci Extensions

This trading technique is similar Fibonacci retracement. However, instead of projecting retracements within the range of the swing, it projects extensions beyond the swing and is useful for planning price targets.

We used the same chart as earlier examples but included more price action to the right of the chart. The black extension lines are possible resistance levels.

The 23.6% level was a decent conservative target. There was also a minor resistance at the 100% extension level. Some of the extension levels acted as support which demonstrates the flipping of resistance to support.

Fibonacci Circles & Arcs

Apparently, straight lines are not enough. Let’s bring market geometry to another level. Come on, bring the circles in.

These circles add a time element to Fibonacci trading. The curves are reminiscent of parabolic chart patterns and the Parabolic SAR trading indicator, which come from the concept of accelerating prices.

The top of the swing acts as the center of the circle. Draw a circle using the swing as the diameter and you get the 100% circle level. Then, use Fibonacci ratios to calculate different diameters for the other circle levels.

Circle trading uses entire circles as potential support and resistance level while arc trading uses only the bottom half of the circles (below the red line). As you can see from the example above, the 61.8% circle level was a great support for price. The other levels are less impressive.

Fibonacci Time Extensions

Apply Fibonacci extensions to the horizontal time axis and you get Fibonacci time extensions. The extension lines mark out when we can expect the market to turn.

In this example, the 138.2% and 200% extensions caught the turning points.

Since these are time extensions, do not use this trading technique on charts without a time base.

Another Fibonacci trading technique that uses time is the Fibonacci time zones. It projects time extensions using Fibonacci numbers instead of Fibonacci ratios. From the chosen point, it extends 1 bar to the right followed by 2 bars, then 3 bars. Then, another 5 bars followed by 8 bars and so on. You get the idea.

How to Really Trade with Fibonacci Numbers

Fibonacci numbers are near magical in nature and biology, and are wonderful in design and arts. We might find part of that magic and wonder in financial markets driven by human psychology.

At least some academics agree with the power of Fibonacci numbers in financial markets.

However, Fibonacci trading techniques, like any other trading method, are fallible. Do not attach mystical power to it.

Regardless of whether Fibonacci numbers are magical, they offer a useful framework for analyzing price action. For example, 38.2% retracement is a shallow pullback and 61.8% is a deep pullback. Instead of blindly classifying pullbacks, we have a framework to help us assess pullbacks.

The Fibonacci trader needs to exercise discretion in two main aspects.

First, we need to choose the swing that serves as the basis of our Fibonacci projections. We need to decide what is a market swing and adjust the selected swing as price action unfolds. A rule of thumb is to focus on major and clear market swings. Do not clutter your charts with too many lines and curves. (A common trap for Fibonacci traders.)

Second, we must decide if the projections are effective support/resistance. As shown in the examples above, not all projected support/resistance levels work well. Looking out for reversal patterns at projected Fibonacci levels is an effective trading method.

You can also consider other ratios in your projection. Some popular ratios we did not include in our examples are 50% and 78.6%. 50% is not a Fibonacci ratio but it works well. I find the zone between 50% and 61.8% useful for Fibonacci retracements. As for 78.6%, it is the square root of 61.8%.

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