What is Fibonacci trading and does this retracement tool really work? It's a visual technical analysis indicator that uses math to calculate the support and resistance levels of a stock. Fibonacci levels are a numbers series. Example: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 are Fibonacci trading levels. Each new number is the addition of the two numbers before, which are added together.
What Is Fibonacci Trading and Does It Work?
- Fibonacci trading is the use of levels figured out by math to find entries, exits, support and resistance as well as stop loss levels. Let's say, for example, that a stock moves up a dollar. Traders believe that a pullback will happen within the fibonacci retracement levels; such as 23, 38, 50, 62, 76 cents.
This trading strategy that many traders like to use for entries and exits. The video above gives you an in depth look on the basics of Fibonacci retracement tool and how to use this strategy when swing trading.
The fibonacci retracement tool is a strategy developed thousands of years ago by a mathematician Leonardo Pisano. His nickname happened to be Fibonacci. I absolutely love finding Fibonacci in different ways throughout life, be in the pedals of a flower, or stock prices on a chart.
This trading strategy simply uses math to determine support and resistance levels. However, some traders almost see this as a crystal ball into a stocks future and rely heavily on Fibonacci trading. As long as it works for you, that's all that matters.
In fact, Fibonacci can be seen in nature and hence how the Fibonacci system came to be. In essence, this mathematician saw the correlation between numbers and nature (try our stock picks service free).
1. Basics of Fibonacci Trading
Fibonacci levels are a series of numbers. For example, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 are Fibonacci trading levels. Each new number is the sum of the two numbers before it added together.
These numbers correlate with spirals in nature such as seashells, constellations and even the human body. How does this work with trading the stock market? The market trades in cycles.
Those cycles form trends. A move in the same direction of the trend is known as an impulse. When a move goes against the trend, it’s known as a pullback.
It uses the retracement levels to see where pullbacks can reverse so that price moves back in with the current trend. This can be very helpful in trend trading.
Fibonacci retracement levels can provide entry levels on a trade. Why? Because when a stock is in a strong trend, Fibonacci traders believe pullbacks will happen at Fibonacci trading levels (check out our day trading strategies page).
2. Retracement Tool
Retracements are at higher levels when price is gaining or losing steam within trends. You can use fibonacci trading for confirmation with both longing and shorting.
Fibonacci trading levels point out price levels you should be aware of. Why? Because simply put, the Fibonacci retracement tool is support and resistance levels.
It’s important to remember that Fibonacci trading is subjective. Stocks have many price swings throughout the day. This means not every trader will be connecting the same two points on retracement levels.
How Do You Trade Fibonacci Retracement Levels?
- How do you trade fibonacci retracement levels? It's quite simple. These levels show important support and resistance zones. These zones are very important guides that show when to potentially enter and exit a trade. If price holds retracement support then buyers might go long. When price rejects resistance levels then they make take a short.
Your price points may differ from that of another traders. This means you’d have to draw retracement levels on every significant price movement.
When the levels are grouping together, that’s a clue that that is an area of significance. We show how to use fibonacci live each day in our trading rooms.
1. The Pullback of Fibonacci Trading
Fibonacci trading has a few different strategies you can employ. The pullback strategy being one. A strong trend usually works best for the pullback method (learn more about shorting).
A strong trend using Fibonacci trading is seen as a stock with many highs that have pullbacks less than 50%.
For day traders, Fibonacci trading works best on 5 minute charts only after the market has been open for at least a half hour.
Look at how price reacts around different retracement levels after finding the morning high of day. If you see trading slowing down or turning, you can place an entry.
You can even use the high of day or highest Fibonacci retracement level as a price point to close out the trade. Have a plan and trade the plan.
Things go wrong in trading all the time so expect it. Price may not make it to the retracement level you thought it would and that’s ok.
2. Trade the Breakout
Did you know that breakout trading has the highest failure rate in the stock market? The reason for this is many times, breakouts end up being fake outs.
Many times it can be market makers getting traders to bite so they can close out a trade which then causes price to fall again.
Fibonacci trading uses extensions to confirm real breakouts. Once price clears an extension level and keeps moving in the trend direction, traders see that as a breakout confirmation.
However, you need to make sure you have volume along with the breakout. Volume is an incredibly important part of trading.
If you get in a trade where there isn’t any volume, you’re going to be stuck in that trade for awhile. If you’re under the PDT rule, your funds can then be tied up in a trade that isn’t working out for you, while you watch better trades happening.
3. Volume & Fibonacci Trading
Volume plays a huge role in Fibonacci trading. Look at the volume when price reaches retracement levels along with a candlestick that falls into your trading plan.
If volume decreases at key support levels, i.e. retracement levels, that doesn’t mean interest in the stock is waning. In fact, it most likely means that sellers aren’t going to push price below support.
Hence buyers come in and price moves back up. The float can be a catalyst to the volume of a stock. Low float stocks tend to move more quickly than higher float stocks. Read our post on what does float mean in stocks.
The Bottom Line
Fibonacci trading isn’t going to pinpoint exact market and stock turning points. However, it can be great for estimating them. They can act as confirmation. If you'd like to receive our customized fib levels (much better than stock!) and watch our private trading video on fib trading, join our community today for instant access to our private training video library!
You don’t need Fibonacci trading to be successful however. For our co-found Dan, they are essential to his trading plan. Play around with the and if you find that they’re helpful to your style of trading too, then implement them.