Fibonacci levels: what are they?
Traders use support and resistance levels to predict the price movement of an asset. The first level keeps the price stable and prevents it from falling further. The second is the point at which the price reverses, moving from the bottom to the top. Traders try to identify them using a technical analysis method known as Fibonacci levels.
The sequence of Fibonacci numbers determines the existence of Fibonacci levels. It looks like this: It goes from 0 to 1, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. In other words, each number is the product of two previous numbers; for example, 3 is the product of 2 and 1. This series has no end. Each number is approximately 1.618 times larger than the previous one. The specific ratios used to construct Fibonacci levels are based on this pattern between numbers.
Fibonacci levels mainly use ratios of 23.6%, 38.2%, 50%, 61.8%, and 78.6%. To get each ratio, you can divide one of the numbers in the sequence by the other. If we divide one of the numbers by the next one, we get the key Fibonacci ratio, which is 61.8%. To illustrate, 21/34 = 0.6176 and 55/89 = 0.61798. Divide the numbers on either side of the other number to get the ratio of 38.2%. For example, 55/144 = 0.38194. Any of the numbers can be divided by the number three places to the right to get a factor of 23.6%. For example, 8 / 34 is 0.23529.
Each Fibonacci level shows the amount by which the price of an asset has corrected in relation to its historical value. Fibonacci levels are often used by traders because they can be plotted between any two price positions. Suppose the price of a cryptocurrency rose by $10 and then fell by $2.36. The price correction in this case was 23.6%, or the Fibonacci number. Fibonacci levels are used in technical analysis to help traders determine the points at which an asset’s price may stop rising or falling and reverse.
How to use Fibonacci levels
Depending on the current value of an asset, Fibonacci levels help traders to predict its price dynamics. Thus, Fibonacci levels can be used by traders who use different trading methods. Long-term traders pay attention to support levels. In other words, they show the lowest price level from which quotes can rise and fall. Those who open short positions (short) should pay attention to resistance levels. In other words, they set the possible upper limit of an asset’s price before which quotes can drop.
Fibonacci levels cannot be calculated using any formulas. The investor chooses two points on the security price chart when he wants to use this indicator. He can then use lines to depict the percentage difference between these two price points.
For example, the price of the cryptocurrency BTC rose from $15666 to $31076. Fibonacci levels are plotted using these two price levels as starting points. The 23.6% threshold in this case is $27439
($31076 – ($15410 * 0.236) = $27439).
($31076 – ($15410 * 0.5) = $23321) is the 50% level.
When the market moves up or down, Fibonacci levels are applied. Fibonacci levels in this situation allow investors to predict the value of securities. According to this concept, the price of an asset “corrects” or returns to the previous price level when the trend reverses. Then it starts moving again in the direction of its trend. Fibonacci levels are easy to calculate in an investment service or in a trading terminal.
Disadvantages of Fibonacci levels
You can use Fibonacci levels to make predictions based only on the history of stock prices. They do not correspond to how the market reacts to news, company management statements, or financial reports. Because of this, many traders base their investment strategy on fundamental research rather than Fibonacci levels.
To put it simply, Fibonacci levels are a kind of numerical model. They are not based on factual information and are not supported by logical arguments. Fibonacci levels also do not provide clear guidance to help investors decide whether to buy certain companies or not; rather, they serve only as retracement or support levels. For this reason, it is better for new investors to open long positions and use fundamental analysis.
Books about Fibonacci in trading.
R. Fisher’s book Fibonacci Sequence: Applications and Strategies for Traders provides another perspective on the use of Fibonacci levels in wave counting.