Fibonacci Ratios and Market Cycles

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Video Transcript:

Hello, traders. Welcome to the 7th Module of the Advanced Technical Analysis Course: Harmonic Patterns.

In this lesson we’re going to teach you about Fibonacci ratio, and market cycles and how to draw your Fibonacci ratios ,and why they are important for us in this part of the Advanced Technical Analysis Course. In fact, you will be using Fibonacci ratios not only to trade harmonic patterns, but you can use it in your everyday training. Just to trade a pull back and to find areas of resistance or support where you think the pull back might end and you can trade with the trend. But, I digress. Let’s get started.

First of all, a little bit of history about Fibonacci ratios. Leonardo Fibonacci discovered a simple series of numbers that create ratios describing the natural proportion of things. The series is derived by starting with a 0 and followed by 1, then adding the first two numbers to get the third. So, he added 0 and 1, and he got 1. The third number of the series is 1. Then he added a second number and third number to get the fourth number, which is 3, etcetera. And the series looks a lot like this, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etcetera. And as you can see, it exponentially gets bigger as it goes along.

Fibonacci Numbers

Now, you might think that just having this series of numbers is not as important in trading. But the thing about this series is the ratios behind it. For example, if you measure the ratio of any number to the succeeding higher you get 0.618. For example, if we divide 30 by 21, you get 0.618. If you divide 34 by 55, you get 0.618. And this is the golden ratio, traders, 0.618 is the most used ratio when you are actually trying to trade with Fibonaccis.

There is another ratio that is derived and that is actually important from the series. If you measure the ratio between alternate numbers you get 0.382. For example, if you measure 55, or if you divide 55 by 144, you get 0.382. And other Fibonacci ratios that we are going to be using in trading are derived from this series.

Now, let’s get to the actual Fibonacci retracement levels and extension levels. First of all, the retracement levels. Fibonacci retracement levels are ratios that we use in trading to find possible areas of support and resistance after a pull back. The ratios that we are going to be using for our harmonic trading is the 236, the 382, the 50, the 618, the 764 and the 0.886.

Usually the 0.886 is a Fibonacci ratio that is not… other default settings of your Fibonacci, too, but it’s super important when you are trading harmonic cycles. These ratios are grown from low to high in an up wave, and from high to low in a down wave. Because these levels are possible areas where the pull back might end in an up move, you draw from low to high, and then you get the areas, the possible areas where the pull back might end and the trend might continue. And in a down move, you draw from high to low because the pull back is the up side. And we’ll find these Fibonacci ratios as resistance before continuing with the down move. That is the simple way to approach Fibonacci retracement levels.

Now, Fibonacci extension levels. The Fibonacci extension levels are ratios that we use in trading to find possible target areas after using the retracement levels. So basically the retracement levels are levels that you use to enter a trade, and the extensions levels are levels that you use as possible targets for the weight exhaustion. And because these are entries and also exits, you can actually measure the length of a wave within a cycle. Now the extension levels that we are going to be using is the 1, the 1.13, the 1.27, the 1.382 and the 1.618. Of course, there are more FIbonacci extension levels like the 2.24,but in this case, we are not going to be using it in our harmonic pattern search. The ratios are drawn from low to high back to the retracement zone in an up wave, and from high to low and back to a retracement zone in a down wave.

Now let’s go to a chart so you can better understand how to draw these Fibonacci levels and how they are used. As you can see here we have the Aussie-US Dollar daily chart and we have the first of them right here. To draw the Fibonacci levels, we treat this low and this high as our low and high for the retracement level. And as you can see here, price at the 764 levels to the peak and then continued to the up side. And to draw the Fibonacci extension levels, we pick this low, this high and then we finish with this low right here, right at the retracement level to get the Fibonacci extension 113 and the Fibonacci extension 1.618.

Fibonacci Levels for Trading

And, as you can see, had we had entered here of the 764, we could have exceeded half of our position at the first extension which is the 113, and then the last at the 1.618 Fibonacci extension. And because we are trading market cycles and because we are trading natural ratios, these tend to work fairly… this tend to be fairly accurate. The thing is that you need to use high-conflicted areas in order for you to get a better entry and better exits.

But this is the basic of Fibonacci trading that you need to know in order to start trading market cycles and harmonic patterns.


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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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