Module 2: Understanding Fibonacci Ratios
What are Fibonacci Ratios?
Fibonacci ratios originate from the Fibonacci sequence, a series where each number is the sum of the two preceding ones (e.g., 0, 1, 1, 2, 3, 5, 8, 13, etc.). In trading, these ratios are powerful tools for identifying potential market reversal points or continuation zones.
Key Ratios used in Trading?
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0.382 (38.2%): Commonly used to identify shallow pullbacks. It suggests that a market will retrace 38.2% of the original price move before resuming its trend.
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0.500 (50%): A widely recognised ratio representing the halfway point of a market correction, though not technically a Fibonacci ratio.
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0.618 (61.8%): This is considered one of the most significant Fibonacci levels. Traders often see it as a key support/resistance zone where reversals are likely.
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0.786 (78.6%): Derived from the square root of 0.618, this ratio is used when the retracement is deep but still within the boundaries of a reversal potential.
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1.000: Represents the completion of the previous move, meaning the market has returned to its starting point. Traders look at this level to anticipate extensions or new trends.
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1.272 & 1.618: These represent Fibonacci extensions, signalling how far the market might extend after completing a retracement. The 1.618 ratio is especially critical for predicting where price might go next.
How to use Fibonacci in Trading:
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Retracements: These levels identify how much a price has retraced from a previous move. By applying Fibonacci retracement tools (available on most charting platforms), traders can forecast where prices might reverse or stall before resuming their original trend. You place the tool from a significant high to a low or vice versa, allowing you to mark out key support/resistance levels.
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Extensions: After a retracement, Fibonacci extensions are used to forecast how far a price might travel beyond the previous high/low. These extensions help traders set profit targets or identify where a trend might continue.
Example of Fibonacci retracement and extension:
Refer to the chart below that showcases the application of key Fibonacci levels, including 0.382, 0.500, 0.618, 0.786, 1.000, 1.272, and 1.618.
This chart illustrates the Fibonacci levels applied to a price swing from low to high. Notice how the price finds support on the 78.6% retracement level, showing how Fibonacci levels act as powerful support/resistance zones during price movements.
Another example below shows how Fibonacci ratios applied to an actual price chart of a swing from low to high reveal how prices react to key Fibonacci levels.
In this case, the price found support on the 78.6% retracement level, indicating how these levels can predict areas where markets may reverse or pause before continuing in their trend.
Lesson Summary
Fibonacci ratios are essential in analyzing market behavior, helping traders forecast potential reversal points or continuations. By understanding the significance of retracement and extension levels, traders can develop strategies for identifying key entry and exit points in the market.
Key ratios to remember:
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Retracements: 38.2%, 50%, 61.8%, 78.6%.
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Extensions: 127%, 144%, 161.8%.
Exercise
Apply Fibonacci retracement tools to various swings (highs to lows) on charting platforms like MetaTrader or TradingView. Practice observing how prices behave around these key levels to better understand potential support and resistance zones.