# Day Wave Trading With Fibonacci Retracements

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Contents

## 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.

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## 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.

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.

## What are Fibonacci numbers?

Fibonacci series are numbers starting with 1 and adding the prior number to get the forward number. Therefore, 1 + 1 = 2, 2 + 1= 3, 3+2 = 5, 5+3 = 8, 8+5 = 13, 13+8 = 21 and so forth. These generate the Fib number series 1,2,3,5,8,13, 21. The series goes on infinitely but for example’s sake we’ll stop at 21. When the prior number to any Fib is divided into the forward number and vice versa, the result is a variation of .618. This is called the golden ratio, which can be found in nature, the curvature of a snail shell to the formation of galaxies. The .382 is derived from dividing a number by two spaces forward or preceded in the sequence.

## Fibonacci Retracement Levels

The .618 and .382 are the two most important Fibonacci (fibs) ratios in the markets. This is likely due to theory that human emotions can be tracked with fibs as well. The .618 and .382 are inflection points where fear and greed result in price action. These are the retracement levels most likely to generate a reversal price move. Therefore a pullback to the .618 price level usually results in a bounce on an up trend. A bounce to the .618 price level usually results in a peak and sell-off in a downtrend. For traders the key fib retracement levels are as follows: .382, .50, .618, .786 and .886. Fib extension levels are 1.27, 1.414 and 1.618. A whole number can be added as the pre-fix moving forward. Most direct access-trading platforms have Fibonacci retracement drawing tools. Check with your broker for this useful tool.

## Drawing Fibonacci Price Lines

To understand the impact of fib levels, it’s best to practice drawing fib lines. These can be uncanny in their accuracy for turning points. Seeing believing. When a stock makes a high and a low, connecting the two points up and back down produces a set a of fib retracement levels in both directions. There is much conjecture as to where the high and low plot points should start. This depends on how far back you decide to use for high and low points. The rule of thumb is that longer time period fibs tend to have stronger support and resistance levels but are also much wider price ranges, very similar to any moving averages used on a weekly versus a 15-minute.

Fibonacci Retracement Levels

Intra-day traders can start with a 15-minute time period chart and plot the high and low points going back up to three months. The key is to have a very distinct high and low. In the illustration of Apple, Inc. (NASDAQ: AAPL), the fib low point was 89 on 5/13/2020 and the high point was 100.73 on 5/26/2020. Note the current date on the chart is 7/5/2020. Once a high and low range is established, then the retracement levels can be determined. In this example, we plot the high to low fib retracement from 100.73 to 89 and then plot back up from low to high 89 to 100.73. This generates fib retracements in both directions. The .382 and .618 overlap forming an overlapped fib, which is a very significant level. Once the fib lines are set, then the playing field is mapped out. The uncanny accuracy of fib lines have to be seen to be believed.

## How to Use Fibonacci Retracements

Keep in mind fibs are simply one tool and should be used in combination with other indicators and or a trading methodology. Fibs give a trader a heads up on significant price inflection points that the trader can watch for a potential trade. Usually a 20 cent overshoot can be used. On the example with the 15-minute AAPL fib chart, you can see how the circled pink fib levels played a key role in either a reversion bounce or a breakout point. Keep in mind that fibs are static, so they do not change, like moving averages. The only time to re-draw fib lines would be when the high or low of the plot points is surpassed.

Fibonacci Retracements applied to an AAPL chart.

Taking a look again at the AAPL fib chart, notice the double top on AAPL forms a rejection at the 98.22 fib thereby causing a collapse to the 96.25 key overlapping .618/.382 fib support, where it bounces all the way back up towards 97.70 before peaking and selling off again. This time the 96.25 fib support cracks as AAPL sells down towards the 94.87 fib before bouncing again back up through the 96.25 fib and chopping until a gap down. The 93.48 fib maintains resistance triggering a sell-off down to the 91.51 fib at the .786 level before setting up a reversal rally back up through the 93.48 and then a cup and handle breakout at the 94.87 fib that squeezes AAPL up to the overlapping .618/.382 fib resistance at 96.25, where it peaks and sells off again back through the 94.87 fib.

To be more effective with fibs, it’s recommended to consider using a price tracking indicator like moving averages in conjunction with a momentum indicator like MACD, RSI or stochastics can help time more precise trades at the fib levels. Practice makes perfect. Traders should continue to draw fib levels on their core stocks and just observe how well they provide reversals to gain first hand experience and most importantly to build trust in them. While no indicator or tool is 100% accurate, the fib retracement lines can be very effective when they are applicable. This is why they should only be another tool in a trader’s arsenal and not the sole tool. The more convergence between a trader’s tools, the higher the probability for a profitable trade.

When planning a swing trade, it helps to expand the chart time frames to include daily and weekly charts. Remember that just because a chart is on a 15-minute time frame, it will still encompass months of a price range. It’s important not to draw too many fib lines on too many time frames so as to saturate the charts with too much data. A good medium is to include one set of weekly fibs, then no more than two sets of 60-minute or 15-minute fibs. This provides wider time frame and intra-day time frame fibs that can be drawn once and used for at least three or more months until the range breaks. Larger time frames like the weekly will be much tougher to break the range and it is possible to have fib lines that don’t require re-drawing for up to a year. Earnings season is usually when the most material news is released which can result in new highs or lows. Fibs are natural turning points based on human emotions. Although algorithm programs run the markets, humans are still programming them and being gamed by them.

## Fibonnaci

Named after 13th century mathematician Leonardo Fibonacci, the Fibonacci Theory consists of a sequence of numbers. Every number in the sequence (0, 1,1,2,3,5,8,13,21 etc) is obtained by adding up the two preceding numbers. Traders derive technical indicators from this sequence, through various mathematical artifices.

No one knows why Fibonacci-derived technical indicators work, but they do seem to work. This bears repeating, because the actual science behind this theory does not really exist…

## The Golden Ratio

The significance of this number-sequence extends beyond its apparently self-generating nature. If you divide any Fibonacci number with the one that precedes it in the sequence, you get approximately 1.618 – the Golden Ratio. The first few numbers in the sequence are exempt from this rule.

One can obtain several other such ratios by dividing numbers from the sequence with numbers other than the one preceding them. Fibonacci ratios also used in technical analysis are: 0.236, 0.382, 0.618, 1.618, 2.618 etc.

The golden ratio of 1.618 is not just a mathematical artifice. It is a number present all over nature. From the petals of flowers to the veins in the leaves, it is quite ubiquitous.

## Fibonacci Retracement Levels

Fibonacci retracement levels and Fibonacci extensions represent some of the most popular uses of the theory for technical analysis.
The significant Fibonacci levels are: 23.6%, 38.2%, 50%, 61.8%, 78.6%, 100% etc. Horizontal lines drawn at these price levels act as support/resistance levels for price action.

How do you calculate these Fibonacci retracement levels? To do it, you need two price points: usually a swing high and a swing low. Technical analysis platforms such as MT4 and Tradingview will automatically calculate the retracement levels for users. All one has to do is to click on the swing high and drag the cursor to the swing low.

If lacking such a platform, you can still calculate the levels using a simple formula. Let us consider the following example: your price rises from \$10 to \$20. \$10 is thus your swing low, while \$20 is your swing high.

Your 23.6% retracement level is located at: \$20-(\$10×0.236) = \$17.64. Your 38.2% level on the other hand is at: \$20-(\$10×0.382) = \$16.18.

### How do you use these levels once you have them set?

The Fibonacci retracement levels tend to act as support levels as long as the price is above them. If the price drops, it will likely bounce off these levels. Once it breaks through them however, they become resistance levels for a subsequent upwards move.

## Fibonacci Extensions

Unlike Fibonacci retracement levels, Fibonacci extensions predict where a strong price wave may end up.
Technical analysis platforms, which support a Fibonacci extension tool, will generate extensions automatically.

As mentioned, by dividing a number in the Fibonacci sequence with a previous number, one will get the golden ratio. By dividing it with a number that is two places to the left in the sequence, one will get an extension ratio. This can be expanded to divisions with numbers three and four places to the left etc.

Unlike the retracement levels, extension levels require three price points: a swing high, a swing low and a point in-between. This third price point is the pullback.

## Other Fibonacci Theory-based Indicators

In addition to the above, technical analysis uses the Fibonacci theory in a number of different ways.

– Fibonacci Time Zones
– Fibonacci Arcs
– Fibonacci Fans

The Fibonacci Time Zones depict various points in the future, where major price swings can occur.

Fibonacci Fans are also areas of support/resistance. Unlike the retracement levels, these lines are diagonal.

Fibonacci Arcs are half circles, which also depict areas of likely price support and resistance.

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