What is the Fibonacci trading strategy?

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Leonardo Pisano, nicknamed Fibonacci, was an Italian mathematician born in Pisa in 1170. His father worked in a trading post in the Mediterranean, and the young Leonardo traveled a lot in pursuit of his studies in mathematics.

In his book, published in 1202, he helped popularize the Hindi-Arabic number system in Europe and presented a now-famous number series named after him. In the Fibonacci number sequence, each number is the sum of the previous two numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 and so on extending to infinity. Each number is approximately 1,618 times larger than the previous number.

The golden ratio

This 1618 figure is called the Phi or Golden Ratio and it appears mysteriously frequently in the natural world, architecture, fine arts, and biology.
This ratio has been observed in Leonardo da Vinci’s Mona Lisa, rose petals, shells, tree branches, human faces, ancient Greek vases, and even the spiral galaxies of outer space.

Why is Fibonacci analysis so popular in trading?

The Fibonacci number sequence has been translated into an investment strategy, allowing you to see the beauty of nature on financial charts.
Fibonacci levels provide objective price benchmarks and thus remove subjectivity (when used correctly) and make more informed decisions.

What is a ‘Fibonacci retracement’?

The Fibonacci Retracement is a very popular tool used by many technical traders to help identify strategic places to trade, target prices, or stop losses.
According to this strategy, after a significant up or down price movement occurs, new support and resistance levels can be found using a simple mathematical formula.

Fibonacci Levels in the Financial Markets

Fibonacci retracements in the context of trading are not numbers in a sequence, but a representation of the mathematical relationships between the numbers in it:

  • The Fibonacci ‘golden’ ratio of 61.8% comes from dividing a number in the series by the number that follows. For example, 89/144 = 0.6180.
  • The 38.2% ratio is generated by dividing a number in the Fibonacci series by the number two places to its right. For example: 89/233 = 0.3819.
  • The 23.6% ratio is derived by dividing a number in the Fibonacci series by number three on the right. For example: 89/377 = 0.2360.
  • Fibonacci retracement levels are applied by marking the ratios of 23.6%, 38.2%, 61.8% horizontally between the highs and lows on a chart, to produce a grid. These horizontal lines are used to identify potential price reversal points.

Difference between Fibonacci retracements and extensions

Fibonacci retracement levels can be used to forecast potential areas of support or resistance, at which point traders can enter the market trying to catch the initial trend when it resumes its course.
Fibonacci extensions can complement this strategy by giving traders Fibonacci-based profit targets.
Fibonacci extensions consist of levels that exceed the standard 100% level and can be used by traders to project areas that generate good potential exists for their trades in the direction of the trend. The main Fibonacci extension levels are 161.8%, 261.8%, and 423.6%.

Fibonacci Trading Strategies

While the use of Fibonacci levels is extremely important in our opinion, by themselves they are not always reliable, like any other form of technical analysis.
By combining Fibonacci with other technical tools, we can increase our chances of success.
You can look for the convergence of a Fibonacci level (especially the 61.8 or 78.6 percent retracements, or the 161.8 or 261.8 extensions) with other support/resistance lines, trend lines, highs/lows important, and the 50 or 200-day moving averages.
In Head and Shoulders, for example, which is a major reversal pattern, the right shoulder sometimes converges with the 61.8 or 78.6 Fibonacci retracement level, thus providing an ideal entry point.

Fibonacci Mistakes To Avoid

There are common mistakes traders make when applying Fibonacci retracements to market charts:

  • Stay constant
  • Using a candlestick chart, consistent Fibonacci benchmarks will measure the close high to the close low. Mixing up the points would mean measuring from the closing high to the lowest point of the day.
  • Zoom out
  • Inexperienced traders often measure significant movements in the price of a stock in the short term, while ignoring the long term. A stock may appear to be trending down over the one hour period, but it has actually been trending up for several days.
  • The basket and the eggs
  • Relying on Fibonacci alone is a mistake. Use additional tools like Elliott Wave to check Fibonacci results and help you find a good trade.
  • Less is less
  • Do not use Fibonacci in short intervals as the market is volatile. Applying the Fibonacci retracement in a short period of time produces less reliable retracement levels. As with any statistical study, more data leads to better analysis.

About the author

Nafees Saifi // entrepreneur, author, trainer, and stocks and FX trader. 
Nafees Saifi is a professional FX trader from, India. Nafees has extensive experience trading commodities, bonds, and equity futures in the Asian, European, and US markets. Nafees holds a Bachelor of Finance and Economics degree and is focused heavily on Investment Finance and Quantitative Analysis.


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