Using Fibonacci in Technical Analysis
No one ever said technical analysis was easy.
But over time, with practice, the easier it becomes.
For months, we’ve introduced you to several technical tools. The one we get the most questions about, though, are Fibonacci retracements.
Though many traders have been exposed to retracements, some dismiss it once they realize it’s based on the ancient work of a 12th century mathematician. They think it’s too complex.
But to be very honest, it’s not complex at all once you understand it.
Typically, Fibonacci levels are based on the belief that stocks, and indexes have a tendency to retrace prior moves. To find our points of reference, we must first identify two extremes on a chart, including the peak and trough. Then, we must divide by key Fibonacci ratios, such as 23.6%, 38.2%, 50%, 61.8%, and 76.4%.
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Once those levels are identified, we then draw our horizontal lines at each % marker to define points of support and resistance. The goal is to help traders determine critical points where a stock is likely to move up or down based on historical support and resistance.
We can illustrate its effectiveness as a great tool with the U.S. dollar, for example.
We begin by finding our peak and trough. We then draw our horizontal lines, which help us identify areas of support and resistance. We can then begin to see the critical points at which the currency has bounced or failed since September 2017 began.
Notice how the retracement levels clearly define support and resistance points along the way. We can see that the currency broke below its 38.2% retracement line, giving us firm indication of further potential weakness.
The question then becomes, “should such an indicator be used alone?”
And the answer is always, “no.”
There will never be a time when it’s okay for a sole technical indicator to be used. Instead, to get a fuller picture, use retracements with other tools such as Bollinger Bands, relative strength (RSI), MACD, Money Flow (MFI), or even Williams’ %R (W%R).
While such charts may not seem useful, they truly are, especially when used with other strong technical pivots. It’s just another strong tool to keep in your trading arsenal.
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