Fibonacci Percentages – Fibonacci Retracement and Extensions

Important Facts and Information about Fibonacci Percentages

The Fibonacci Percentages are primarily based upon a sequence of Fibonacci numbers, one of which (61.8%) is known as “the golden ratio” because it occurs many times in nature. The Fibonacci sequence actually first appeared as a solution in the Liber Abaci’s problem. In 1202, a book was then written by Leonardo Fibonacci to introduce the Hindu-Arabic numerals that are used widely today, to a middle ages Europe that was still using the Roman numerals.

The Fibonacci numbers have been used in forex trading, especially in connection with technical analysis. Some even call the 61.8% retracement in a trend, the “fire your boss” level. They are also very popular in connection with stock and options trading circles because they identify likely pullback targets in trending markets before the stocks resume their current direction.

Essential Retracement Levels With Fibonacci Percentages

The Fibonacci Percentage retracements are used to identify potential resistance or support levels. The most common Fibonacci levels that are being used are 38.2%, 50%, and 61.8% with some other percentages that serve as secondary levels.

Here are three profit tips for those who are using Fibonacci:

1. Fibonacci Percentages define stop loss levels

A trader can always utilize the Fibonacci numbers to set stop-loss orders. Fibonacci numbers are useful for defining stops if the trader has traded off a support level and this support level is being violated. When the price action breaches a perceived support level, the 50.0% or 61.8% areas from the original price peak can be chosen to exit the trade.

Alternatively, the trader may adopt the policy of entering a trade when there is a confluence between the 61.8% retracement level following in impulse move, and either a trend line or previous support or resistance (structure – “look left”) depending on trend direction.

Stops may be placed at the 78.6% retracement level and profit targets set for the zero retracement level, or if partial profits are taken there, the remainder may be set for the 127.2% Fibonacci extension level, or higher.

Under the above conditions, the trader receives a 3:1 reward-to-risk ratio. Since the 61.8% retracement is a popular price reversal area, it then becomes a simple matter of probabilities to see an overall profit.

2. Fibonacci Percentages Defines the Portion Size

The Fibonacci numbers can likewise define the position size which depends upon the level of risk that you are prepared to take for your trades.

3. Fibonacci Numbers Define Profit Targets

Using Fibonacci numbers, you can set profit objectives. For example, taking partial profits once the target has been reached according to the anticipated Fibonacci level. The great advantage of the Fibonacci numbers, particularly the 61.8% “golden ratio”, is that they essentially remove emotion from the trading process by pre-defining stop losses and setting your profit objectives.

Moreover, when used in technical analysis, there are 3 main Fibonacci retracement percentages:

• 23.6%,
• 50%, and
• 61.8%.

However, there are also some other secondary extension levels when they are required, including:

• 100%,
• 127.2%
• 161.8%    . . . and so on.

There are also 4 main techniques for the implementation of the Fibonacci sequence to currency trading which include:

• Time zones
• Arcs
• Fans
• Retracements

The 161.8% Fibonacci Extension Level and Pullback Strategy

If you’re a forex or futures trader then what I’m about to share may provide you with a low-risk, hassle-free way to making trading decisions. For options traders, this would be best suited for day trading because it avoids the unpredictability of overnight price gapping.

The 161.8 and 200.0 Fibonacci extension levels are key price reversal levels. Let’s say that price action has made an upward move, then it retraces, followed by a continuation of price action in the direction of the first move. So we have a trend.

A simple trading strategy would be to preset a sell trade at the 161.8% extension level, using a small portion of your capital, with the intention that you will take profits when the price retraces down to the 127.2% Fibonacci extension level (from the original upward move).

Should price keep powering upwards, as it sometimes does, particularly with volatile forex pairs, then you would choose a higher extension level to set your stop-loss. It may be the 200.00% level, or depending on how risk-averse you are, even as high as the 261.8% level.

Or if you’re only prepared to accept a 1:1 risk-to-reward ratio, then you might do this:

Enter at 161.8% extension, prepared for profits at the 127.2% and stops at the 200.0% extension level.

If this fails take a loss and then immediately place a new sell trade at the 200.0% extension with the intention to take profits when it retraces down to the 161.8% level, but with a stop at the 238.2% extension level.

If both trades fail, walk away. You have only lost a small portion of your capital. There will be plenty more trades and the majority will be profitable. If you’re using this for forex trading, be careful to not expose yourself too much to any one currency. If you intend to use it to day-trade stock options or ETF options or futures then you should be fine.

As a final note, I have observed that this type of trade is the riskiest when it is used at a change of trend direction. If you know anything about Elliott Wave Theory, then you’ll understand that “Wave 3” is usually the largest and therefore, the most likely to power through. Better to take these price reversal trades at Wave 5.

In Conclusion

Fibonacci percentage and analysis has always been an important tool for modern investors. Most traders are still cautious about using this form of analysis in all market conditions, but the accuracy and reliability of Fibonacci analysis has made it one of the most well-known and popular signals, particularly to forex traders and by extension, forex options traders.

It is true that there are still many traders who question the scientific basis for it, but Fibonacci percentages in their role as retracement levels and extension targets are still as reliable and dependable as any other tool available to traders today. From personal experience, I believe that savvy traders can gain an edge by using Fibonacci analysis and techniques.