Introduction to Fibonacci Extensions in Trading
In the world of trading, one of the most influential and widely used concepts is that of Fibonacci extensions. Named after the Italian mathematician Leonardo of Pisa, also known as Fibonacci, these extensions are derived from his famous sequence of numbers. Traders use these extensions as a tool to predict potential price targets or areas of support and resistance.
Understanding Fibonacci Extensions
Fibonacci extensions are a method of technical analysis commonly used to predict the end of a trend or a counter-trend bounce. They are based on the Fibonacci sequence, a mathematical pattern where each number is the sum of the two preceding ones, starting from 0 and 1. The sequence goes as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, and so on.
The Golden Ratio
The relationship between these numbers is what gives rise to the ‘Golden Ratio’ of 1.618, also known as Phi. When a number in the sequence is divided by the previous number, the ratio tends to be around 1.618. This ratio is considered to have unique properties and has been found to describe proportions in nature, architecture, and art.
In trading, Fibonacci extensions are percentages based on the Golden Ratio. The most commonly used Fibonacci extension levels are 61.8%, 100%, 161.8%, 200%, and 261.8%.
Application of Fibonacci Extensions in Trading
Fibonacci extensions are primarily used to predict areas of support and resistance. Traders use these levels to identify potential reversal points in the market where they can enter or exit trades.
Identifying the Swing High and Swing Low
The first step in drawing Fibonacci extensions is to identify the most recent ‘swing high’ and ‘swing low’ on the price chart. The swing high is the highest point in the current trend, while the swing low is the lowest point.
Drawing the Fibonacci Extensions
Once the swing high and swing low have been identified, the Fibonacci tool is used to draw the extensions. The 100% level is drawn at the swing high, and the 0% level is drawn at the swing low. The tool then calculates and draws the extension levels at 61.8%, 161.8%, 200%, and 261.8%.
Interpreting the Fibonacci Extensions
The Fibonacci extensions represent potential levels of support or resistance. Traders watch these levels closely for signs of a price reversal. If the price reaches an extension level and then reverses, it’s a signal that the level is acting as support or resistance.
Conclusion
Fibonacci extensions are a powerful tool for predicting price levels in trading. They are based on the Fibonacci sequence and the Golden Ratio, which are found throughout nature and human design. By understanding and applying Fibonacci extensions, traders can identify potential reversal points and make more informed trading decisions.
