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If you are an active day trader, you probably realize that Fibonacci retractions and extensions are the most important and useful tools in all price activity.
Day traders and technical analysts can use Fibonacci level analysis to identify entry levels, target profit taking, and determine stop loss levels.
In this guide, we will explain exactly how to plot Fibonacci levels so that you can better decide when to enter and exit trades.
What are Fibonacci numbers and ratios?
The Fibonacci sequence, sometimes called the Golden ratio, is a string of numbers in which each number is the sum of the first two.
For string 0,1,1,2,3,5,8,13,21,34,55, for example, if we add 0 + 1, we get 1. If I add 1 plus 1, I get 2. If we add 1 plus 2, we get 3, and so on and so on.
The resulting sequence is called the Fibonacci sequence, and each number in the sequence is called the Fibonacci sequence. The Fibonacci ratio is then calculated by divisor over the sequence. These calculations give the ratios used in the Fibonacci levels below.
0, 0.236, 0.382, 0.5, 0.618, 0.786, 1, 1.618, 2.618
These ratios are translated into percentages – 23.6%, 38.2%, 61.8%, 78.6% and so on – and then applied to charts in an attempt to identify potential levels of hidden support or resistance in the market.
The Fibonacci sequence was discovered by the Italian mathematician Pisa Leonardo in 1202 when he was considering a practical problem involving the growth of a rabbit population based on idealized assumptions.
This order governs many aspects of life; From the creation of flowers, to the formation of waves, to the proportions of human bodies. It also provides traders and technical analysts with the information they need to develop resistance and support levels that can be used in a risk management framework.
You can use the Fibonacci level on your own or in combination with other trading methods.
The Fibonacci sequence was used to form other theories, such as Elliott wave principle and Dow theory. You can also use other technical analysis tools to use the Fibonacci ratio.
How to calculate the Fibonacci callback level
One of the most common technical analysis tools derived from the Fibonacci gold ratio is the Fibonacci correction level.
The Fibonacci ratio of 61.8% and The Fibonacci ratio of 32.8% are calculated by subtracting the recent high from the recent low and targeting the upcoming rally. Most of these points can be calculated using graphing software.
As the S&P 500 chart above shows, Fibonacci retractions often act like magnets, creating a self-fulfilling prophecy.
As you can see from the chart, the realization that the coronavirus pandemic was about to hit the US economy triggered a rapid bear market that began in February and bottomed out in March. Prices fell from around 3400 to 2200 before rebounding to a 38.2% retracement level.
If we multiply the drop point by 38.2% and add that number to the low (2200), we get the Fibonacci retracement level of 38.2%, or 2647. The index starts to consolidate at this point.
After the consolidation period, prices retested the 38.2% retracement level and broke through the next level, the 50% retracement level. The merger was short-lived. The S&P 500 then began testing the 61.8% retracement and consolidated around that area.
When you draw the Fibonacci retracement line, you will measure the peak to trough of your target’s movement. Then multiply the difference between high and low by 61.8% and 38.2%.
If you measure a drop, these results are added to the low values; If you measure the rise, these results are subtracted from the high values. When prices rebound, these levels will serve as target support for your corrections or resistance levels.