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Many people ask me if Fibonacci retracements and extensions really work when it comes to trading, and to that I have the following answers.
First off all I would recommend that you go and read my article on Fibonacci sequence Explained. Then come back here and we’ll discuss this further.
I think everyone knows that price moves in a retracement type fashion in any direction accept when it’s trading sideways. If price is going up, it tends to do so in a series of what impulses and corrections.
These impulses and corrections look like this:
There are many different scenarios this particular pattern could be a part of, but the potential for the application of Fibonacci retracements and extensions lies in not only this 5 wave move up, but also and especially in the overall correction of this move.
You see although this is 3 impulse waves, and 2 corrective waves, on the larger scale its one impulse wave. Here’s what I mean:
5 Rules to Perfect Fibonacci Chart Plotting
Fibonacci retracements represent an excellent tool for investors, identifying reversal points on a historical price chart. Anyone can see that on any historical price chart, trading prices will inherently pull back or retrace a percentage of the previous movement before reversing again and then proceeding in the direction of the overall long-term trend.
Historical observations demonstrate that these retracement percentages seem to follow a Fibonacci ratio pattern. By carefully plotting these retracement possibilities on a historical price chart, a trader improves his or her probability towards successful investing. Certain rules are recommended to improve the likelihood of identifying successful entry and exit points.
Rule 1: Identify the High and Low
In order to use Fibonacci retracements, it is important to identify relative high and low prices on a historical chart. The longer the term that is utilized, the more likely the Fibonacci retracement lines plotted will identify significant levels demonstrated support and resistance.
Rule 2: Plot the Fibonacci Retracement Levels
Once a high and low for a time period has been chosen, it will be possible to draw the Fibonacci retracement percentage levels onto the chart. The low point would represent 0%, and the high point represents 100%.
Between these two extremes, one can plot the most significant Fibonacci percentage plot lines of 38.2%, 50%, and 61.8%. It is also beneficial to plot these percentages below and above the high and low. In other words, plot lines that would be 138.2%, 150%, and 200% on the up side above the high, and -30.2%, -50%, and -61.8% on the down side below the low. It should be noted that software exists that will allow you to automatically plot these Fibonacci levels.
Rule 3: Observe Historical Behavior
Once the plot lines have been placed on the chart, it is important to observe at which Fibonacci levels in the historical period under consideration has demonstrated support and resistance. These areas will be objectively seen to show that when approached, retracement clearly resulted.
Rule 4: Forecast Future Movement
The appropriate Fibonacci retracements will vary from investment market to investment market and be a function also of the trading character at any particular time. Consequently, successful use of Fibonacci techniques will be highly dependent on the accurate interpretation of previous price movement activity within the range identified. When the proper Fibonacci retracements have been observed, entry and exit points can be forecasted for position-taking based upon the clearly demonstrated historical record.
Rule 5: Always Have Confirmation
Through study and observation, many successful traders have mastered the techniques necessary for the use of Fibonacci retracement ratios. As anyone can see, however, the support and resistance represented by these levels do not automatically appear at all times. In other words, after the 38.2% retracement, the price may continue in that direction and not stop or reverse itself until perhaps it reaches 61.8%.
What is clear, however, at a certain Fibonacci point, a retracement will occur. As a result of this, the use of Fibonacci techniques is most successful when used in conjunction with other technical analysis tools that confirm what has been identified.