Charting 101 (Guest post): Why do we use Fibonacci Analysis?
Updated: Jul 26, 2022
Thank you for taking the time to read today's blog post. We are inviting Amjad, from the United Araba Emirates, a guest blog the site to discuss Fibonacci Analysis! Please be sure to read the disclaimer on our site before moving forward, comment below and follow us on social media (FaceBook, Instagram, and twitter)!
Why do we use Fibonacci Analysis?
Simply, because it works! And because Price Rules Everything Around Us!
Fibonacci Analysis is a tool that enables traders to establish profit targets or anticipate where the price may reverse after a pullback is finished, and it’s incredible how often these levels are respected and today I’m going to walk you through how we use it.
We know the market tends to respect these levels, so why not incorporate it into our decision making?
The extension levels are areas where the price may stall a little. These levels are based on Fibonacci ratios, Fibonacci ratios are common in everyday life, for the sake of simplicity of this Blog I will not get into the Fibonacci series application and how those levels are calculated (Wikipedia). It’s fascinating!
I want to walk you through the process of how to use this tool effectively. First, let's take a look at how Fibonacci Extensions are drawn on a chart and what are the important extension levels; 61.8%, 100%, 161.8%, 261.8%, 423.6% etc.…. are very common levels and they hold a significant value.
Fibonacci Extensions aren't easy to be drawn, this is the part where most people fail at plotting them.
When we look at any given chart we usually start by checking the most significant drop. But what if there are a lot of significant drops I hear you ask?
I’m going to tell you the secret…
If there are a multiple large declines in price, it’s very simple you need to check them all and observe which decline holds the most weight.
Here is a recent chart for $PDD (Figure 1.1), charted using TradingView.com (twitter @tradingview).
Although this not the most significant drop in price, we can observe that the Fibonacci levels hold significant value and the structure of price tends to respect it. The biggest price drop was back in September 2018 the price dropped a staggering 45%! Yet, we can observe through Fibonacci Analysis that this drop is quite irrelevant longer term (Figure 1.2).
What Do Fibonacci Extensions Tell US?
Now let's take a closer look at Extensions:
Fibonacci extensions are a great way to establish price targets or find potential areas of support and resistance. The theory behind Fibonacci Extensions is that if the price moves through one extension level, it has a big chance to continue moving toward the next extension level.
Let’s take take a look at an example here with the $APPS Chart:
Here, price has broken through 261.8% extension level before advancing toward the 423.6% level before meeting resistance level. Note! Once we broke the 2.618% extension level we did not have to retest to move higher in price! We did hit resistance though at 423.6% and that's where price decided to start to pull back.
Is that a coincidence?
Not in my world.
It’s all very logical. Trust me! The charts don't lie.
Just observe what happened when the price broken the 423.6% level. Price advanced towards the next extension level 685.4% and again we met resistance!
Please note Fibonacci extensions are areas of possible interest. The price may not stop and/or reverse right at the level, but if you’re not paying attention to Fibonacci in this new era of modern technology where anyone can go online and chart price then you’re missing out!
Trust us on this, even the CEO of Essex Trading Apparel, Miguel Ferreira, agrees!
Fibonacci is VERY VERY useful! It's how we make money in the markets!
To sum up, fibonacci extensions are a great tool in the technical analysis world. I would highly recommend you learn how to incorporate them into your decision making side by side with other indicators like RSI & Price action.
It’s worth bearing in mind that there is no guarantee price will ever reach or reverse at a given extension level, so you should not take a trade based solely on Fib Extensions, but it is a very significant data point and as I’ve demonstrated.
It holds a lot of merit. Honest.
About Amjad: has been living in the U.A.E. for 10 years where he currently studies electrical engineering at Sharjah University. Just after a year of trading because of an eToro and he started learning about Technical Analysis and charting. He now uses these tools to make decisions in the market.
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@WizDayTrader, CEO of Essex Trading Apparel