Out of all the Fibonacci trading tools, the retracement levels tool is the most popular and widely used, even though I would not say it is the most important one.
The reason for this being the most popular one is because of the golden ratio, the now famous 61.8% retracement level. Everything in trading relates to 61.8%, especially if one is using Elliott Waves theory to label markets and open a trade.
Other important retracement levels are the 50%, 38.2%, 23.6%, and even 80%, depending on the trading theory used.
According to Elliott, any retracement between 50% and 61.8% after an impulsive move should be interpreted as the second wave before an extended third wave starts. It is no wonder that such a retracement, when hit, attracts a lot of traders in the opposite direction of the retracement, as everyone wants to ride the extended third wave, when quick pips and profits can be made.
The golden ratio has application in corrective waves as well, as flats and zigzags are being classified based on the retracement beyond or until the 61.8% level and on the length of the c wave in the case of zigzags.
Still on the Elliott Wave, extension levels like 138.2%, 161.8% and even 261.8% and 4618% are important ones when calculating an impulsive wave’s extension and looking for targets. Fibonacci trading tools are offered by all trading platforms and the most popular trading platform offered e.g. by CornèrTrader as well, is doing that too.
The 80% retracement is used both in Elliott as well as in Gartley trading methods. Elliott has different flat categories if price is retracing above 80% while the whole Gartley method is actually being built around the 80% retracement as it gives the entry into a new trade.
As it can be seen from the examples above, Fibonacci retracement levels are mostly used together with Elliott Waves theory.
They validate or invalidate a move, and until that specific level comes, one should not exit or enter a new trade.
Some levels like the 138.2% and 161.8% are making a huge difference on the type of a pattern price is making.
For example, let’s assume market is making a wave a and b of a flat. The minimum retracement level for wave b is 61.8% of wave a. However, it can retrace more than 80%, even more than 100%, but still wave c has a very good chance to completely retrace wave b.
However, if wave b is retracing wave a by 138.2%, it is virtually impossible for the c wave to come back and retrace wave b. Moreover, in almost all cases, wave b will go and stretch all the way to 161.8%.
The way to trade this is to stay in the trade until minimum 161.8% comes and then to look for opportunities to trade in the opposite direction.
All patterns under the Elliott Waves theory are correlated with Fibonacci numbers, mostly an internal correlation. For example, a triangle is having five waves, or legs, but a triangle cannot form if 50% retracement between the waves is not happening.
The Fibonacci series is used not only to forecast price, but also time. For this, the Fibonacci Time Zones indicator allows us to have an educated guess also about the time needed for a pattern to form.
In order to use such a pattern, one needs to measure the time taken for the previous wave and project the Fibonacci ratios, in time, on the right side of the chart. Needless to say that the 61.8% plays an important role here as well but ratios like 38.2% and 50% are used in some cases.
Other trading tools are using Fibonacci ratios as well, like the Andrew’s Pitchfork tool. It is known that this is based on three points, the pivots, with three lines derived from these three pivots and the middle one being the most important one. However, other parallel lines can be drown, lines that respect either 61.8% or 161.8% and just like that a Pitchfork is offering some more important support and resistance levels, even though dynamic ones.
Even logarithmic scales take into account Fibonacci numbers, only those are not that famous like the ones a retail trader uses as institutional ones are looking at the bigger picture more often than retail traders do.
Fibonacci arcs or fans are also used by with limited implications. If I were to put the Fibonacci trading tools in the order of their importance, then the retracement levels are definitely the most important ones, followed by extension and time zones. Everything else should be interpreted as being just something derived from the same thing, with 61.8% being the center stage in any analysis that involves a Fibonacci ratio.
All in all, understanding Fibonacci numbers and ratios and knowing where to find them and how to use them is a must for profitable trading. They may seem as easy to use and apply to charts and all, but only integration with a trading theory offers the best results.
In this respect, Elliott Waves theory is the one to use as it is taking advantage not only of the retracement tool, but also the time zones and expansion ones.
Time is everything in trading and sometimes it is even more important than price so having some trading tools to help you timing an entry or exit can only be helpful. Fibonacci numbers allow that, and this is just one other reason why they are so much appreciated by traders.
