What Are Fibonacci Levels?

What Are Fibonacci Levels
.13 Apr 2024
author avatar image Andreas Thalassinos
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Table of Contents

Introduction

Fibonacci analysis is a widely used technical tool to identify potential price levels, profit targets, support, and resistance when trading in financial markets. It’s named after Leonardo of Pisa, commonly known as Fibonacci, an Italian mathematician who discovered the sequence and its related ratios. This powerful technique has various applications in trading and is a popular choice among traders due to its accuracy and efficiency. It helps traders to predict potential market movements and make informed investment decisions.

So, welcome to this guide, where you will uncover the intriguing world of Fibonacci, Fibonacci retracement, and Fibonacci extensions. As a trader, you will thoroughly comprehend these concepts and how they can be effectively integrated into your trading strategies to make sound decisions. So, let’s delve deeper into these concepts and explore them in detail!

Understanding the Fibonacci Sequence

 The Fibonacci sequence is a numerical series defined by each number being the sum of the two preceding numbers. The series begins with 0 and 1 and continues indefinitely, producing 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. As the sequence progresses, the ratio of any given number to its subsequent number approaches approximately 0.618, a value commonly known as the inverse of the Golden Ratio or Phi (φ). Due to its inherent aesthetic and proportional qualities, this mathematical concept has been extensively studied and applied in various fields, such as art, architecture, and finance.

Leonardo of Pisa

The Fibonacci sequence is named after Leonardo of Pisa, also known as Fibonacci. Fibonacci was an Italian mathematician who lived during the Middle Ages, born around 1170 and passing away sometime after 1240. He is credited with introducing the Fibonacci sequence to the Western world through his book “Liber Abaci” (The Book of Calculation), published in 1202.

In “Liber Abaci,” Fibonacci described a problem involving the reproduction of rabbits, which led to the formulation of the sequence. While the sequence had been previously described in Indian mathematics, Fibonacci’s work popularized it in Europe and brought it to wider attention. As a result, the sequence was eventually named after him.

It’s worth noting that the sequence itself appears in various contexts and cultures throughout history, but Fibonacci’s contributions helped establish it as a fundamental concept in Western mathematics.

The Rabbits Question

The Rabbits Question is a classic mathematical problem that asks how many pairs of rabbits will exist in each month if we start with a single pair of rabbits (one male and one female) in month 0, and if each pair of rabbits produces another pair of offspring (one male, one female) every month, starting from the second month. 

Answer

The answer to this question is that the number of pairs of rabbits in each month follows the Fibonacci sequence: 1, 1, 2, 3, 5, 8, 13, 21, and so on. Each number (after the first two) is the sum of the preceding numbers in this sequence. This sequence describes the number of rabbit pairs at the end of every month, assuming that no rabbits die and each pair reproduces a new pair every month.

The Golden Ratio and Fibonacci Ratios

 The Golden Ratio, denoted by the Greek letter φ (phi), is approximately 1.618033988749895. This ratio has fascinated mathematicians, artists, and scientists for centuries due to its aesthetic and mathematical properties. In trading, Fibonacci ratios derived from the sequence, such as 0.618 (61.8%), 0.382 (38.2%), 0.236 (23.6%), and others, are used to identify potential support, resistance, extensions, and retracement levels.

Fibonacci Retracement

 Fibonacci retracement is a popular technical analysis tool for identifying potential support and resistance levels in a financial market. Traders use it to predict potential price corrections or pullbacks within an existing trend. The key Fibonacci retracement levels are 23.6%, 38.2%, and 61.8%.

Consider the Fibonacci sequence and the corresponding ratios:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, …

Dividing a number in the sequence by the third successor yields the 0.236 ratio.

The Fibonacci retracement ratio by dividing 89 by 377.

89/377=0.236

Similarly, dividing a number in the sequence by its second successor yields the 0.382 ratio.

The Fibonacci retracement ratio by dividing 144/377=0.382

144/377=0.382

Dividing a number in the sequence by its successor yields the 0.618 ratio.

The Fibonacci retracement ratio by dividing 55/89=0.618

55/89=0.618

How to Use Fibonacci Retracement During An Uptrend

Retracement in Uptrend
  • Identify the Swing Low and Swing High on a price chart.
  • Draw Fibonacci Levels from the swing low to the swing high.
  • Interpretation: Traders look for price reactions or clusters of Fibonacci levels to determine potential support or resistance zones.
  • Trade Setup: Traders may enter trades near Fibonacci levels with the confluence from other technical indicators or price action signals, such as a Japanese candlestick reversal pattern (i.e., Hammer) and oversold readings on the Relative Strength Index, for example.

How to Use Fibonacci Retracement During A Downtrend

Fibonacci retracement in a downtrend
  • Identify the Swing High and Swing Low on the price chart.
  • Draw Fibonacci Levels from the swing high to the swing low.
  • Interpretation: Traders look for price reactions or clusters of Fibonacci levels to determine potential support or resistance zones.
  • Trade Setup: Traders may enter trades near Fibonacci levels with confluence from other technical indicators or price action signals, such as a Japanese candlestick reversal pattern (e.g., Shooting Star) and overbought readings on the Stochastics oscillator.

Fibonacci Extensions

Fibonacci extensions predict potential future price levels beyond the current trend. Unlike retracement levels, which indicate potential reversal points, extension levels project where the price may move toward the prevailing trend. Common Fibonacci extension levels include 161.8%, 261.8%, and 423.6%.

Consider the Fibonacci sequence and the corresponding ratios:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, …

Dividing a number in the sequence by its predecessor yields the 1.618 extension.

one point sixty one eight

377/233=1.618

Similarly, dividing a number in the sequence by its second predecessor yields the 2.618 extension level.

two point sixty one eight

377/144=2.618

Dividing a number in the sequence by its third predecessor yields the 4.236 extension.

four point twenty three

377/89=4.236

How to Use Fibonacci Extensions During An Uptrend

Fibonacci extension Uptrend

How to Use Fibonacci Extensions During A Downtrend

Integrating Fibonacci into Trading Strategies

  • Trend Identification: Use Fibonacci retracement and extensions with trend analysis to confirm trend direction and identify potential entry and exit points.
  • Confirmation with Other Indicators: Combine Fibonacci levels with other technical indicators, such as moving averages, oscillators, or chart patterns, to validate trading signals.
  • Risk Management: Implement proper risk management techniques, such as setting stop-loss/take-profit orders and calculating position sizes based on Fibonacci levels and market volatility.
  • Practice and Backtesting: Practice applying Fibonacci techniques on historical data and conduct thorough backtesting to assess the effectiveness of your trading strategies.

The Golden Rectangle

A golden rectangle is a specific type of rectangle with a unique proportion known as the golden ratio, often denoted by the Greek letter φ (phi), approximately equal to 1.618033988749895. This ratio is an irrational number, meaning it cannot be expressed as a simple fraction.

To understand the golden rectangle, let’s first define it:

A golden rectangle is a rectangle whose side lengths are in the golden ratio. This means that if you divide the longer side by the shorter side, you’ll get the golden ratio.

Mathematically, if a is the length of the longer side and b is the length of the shorter side of the rectangle, then the golden ratio is expressed as:

a/b​=ϕ

Or, equivalently:

a=ϕb

Human Faces and Bodies: Some researchers suggest that certain facial features, such as the ratio of the length of the face to the width or the position of facial features like the eyes, nose, and mouth, approximate the golden ratio. However, this is a topic of debate in the scientific community.

The unique property of the golden rectangle is that when you cut off a square from it (either from the shorter or longer side), the remaining rectangle is also a golden rectangle. This property continues indefinitely if you keep cutting off squares.

The golden rectangle and the golden ratio have been used extensively in art, architecture, and design because of their aesthetic appeal. They are believed to represent harmony and beauty. Many famous buildings and artworks, such as the Parthenon in Greece and Leonardo da Vinci’s Vitruvian Man, are said to incorporate the golden ratio in their proportions.

In summary, the golden rectangle is a rectangle whose side lengths are in the golden ratio. This proportion is considered aesthetically pleasing and has been widely used in various fields throughout history.

The Golden Ratio in Nature

The golden ratio, represented by the Greek letter φ (phi), appears frequently in nature. It’s often observed in the proportions and arrangements of various biological structures. Some examples of where we find the golden ratio in nature include:

  • Phyllotaxis: The arrangement of leaves, petals, seeds, and other plant structures often follows spiral patterns based on the golden ratio. These spirals can be observed in the arrangement of sunflower seeds, pinecones, pineapples, artichokes, and the patterns of leaves around stems.
  • Shell Spirals: Many shells, such as those of snails and nautiluses, form logarithmic spirals that approximate the golden ratio. The shells grow in a way that each new section is proportionally related to the previous one by the golden ratio.
  • Animal Bodies: The proportions of various parts of animals’ bodies sometimes approximate the golden ratio. For example, the ratio of the length of the human forearm to the hand, or the ratio of the size of certain bones in the fingers, can approximate φ.
  • DNA Molecules: The dimensions and proportions of the DNA molecule exhibit ratios that are close to the golden ratio.
  • Hurricanes and Spiral Galaxies: Large-scale phenomena like hurricanes and spiral galaxies sometimes exhibit patterns that approximate the golden ratio.

While the golden ratio in nature is often cited as evidence of inherent beauty or harmony, it’s important to note that not all instances are perfect examples of φ. Nature’s forms are complex, and while the golden ratio appears frequently, it’s often just one of many factors influencing their shapes and structures. Nonetheless, its presence in diverse natural phenomena has fascinated scientists, mathematicians, and artists for centuries.

The Parthenon

The Parthenon, an iconic ancient Greek temple on the Acropolis of Athens, is often cited as an example of architecture incorporating the golden ratio. While there’s debate among scholars regarding the extent to which the golden ratio was intentionally used in its design, some elements of the Parthenon exhibit proportions that approximate the golden ratio.

Here are some aspects of the Parthenon where the golden ratio is believed to be present:

  • Overall Dimensions: The dimensions of the Parthenon’s facade, including the width-to-height ratio, have been suggested to approximate the golden ratio. Some researchers have claimed that the ratio of the width of the facade to its height, as well as the height to the distance from the centre of the facade to the top of the pediment, approximates the golden ratio.
  • Column Spacing: The spacing between the columns of the Parthenon’s colonnade has been suggested to follow a pattern based on the golden ratio. Some measurements indicate that the distances between the columns may correspond to Fibonacci numbers related to the golden ratio.
  • Frieze and Metopes: The frieze and metopes of the Parthenon are believed to have proportions that approximate the golden ratio. Some studies suggest that the height of the frieze relative to the height of the columns, as well as the proportions of the metopes, may be based on the golden ratio.
  • Overall Symmetry and Harmony: Even if specific measurements don’t precisely match the golden ratio, the overall symmetry and harmony of the Parthenon’s design are often cited as evidence of proportional principles consistent with the golden ratio. The ancient Greeks valued harmony and proportion in their architecture, and the Parthenon reflects these aesthetic ideals.

Some argue that the golden ratio may have been one of several proportional principles used by the architects of the Parthenon, while others contend that its presence may be coincidental.

Overall, the Parthenon stands as a masterpiece of ancient Greek architecture, and its proportions continue to fascinate and inspire researchers and admirers around the world.

Conclusion

Fibonacci analysis is a valuable tool for traders seeking to identify key levels of support, resistance, and potential price targets in financial markets. By understanding the Fibonacci sequence, retracement, and extension concepts, traders can enhance their technical analysis skills and make more informed trading decisions.

However, like any other technical tool, Fibonacci should be used in conjunction with different forms of analysis and risk management strategies for optimal results. With practice, patience, and discipline, traders can master the art of Fibonacci and unlock new opportunities in the markets.

author avatar image
Andreas Thalassinos

Experienced educator with a demonstrated history of working in the financial services industry. Skilled in Technical Analysis, Market Risk, Asset Management, Stock Market, and Trading Systems. Strong professional with a MSTA by Society of Technical Analysts (UK), CFTe and MFTA focused in Master of Financial Technical Analysis from International Federation of Technical Analysts (USA).

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