One of the things that day traders need to keep track of throughout the trading day are support and resistance levels. Useful technical analysis tools that help with this task are Fibonacci retracements. What a day trader works with are horizontal lines on a stock chart indicating where possible support and resistance levels are. The Fibonacci concept goes back more than two millennia to ancient India and was introduced to the West in the late Middle Ages by the Italian mathematician Leonardo Fibonacci. How are Fibonacci retracements useful in day trading?
What Are Fibonacci Retracements and How Can They Help Day Traders?
A Fibonacci sequence is a series of numbers. Each number is the sum of the two preceding numbers. The simplest is 1, 1, 2, 3, 5, 8, 13 and so forth. Such sequences appear very often in mathematics as well as in nature. Fibonacci retracements are derived from Fibonacci sequences. Retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. In day trading these retracement levels help define levels between highs and lows where prices may stall or reverse. As with all technical indicators, Fibonacci retracements should never be used alone as a guide to day trading.
Understanding the Basics of Fibonacci Retracements
Fibonacci retracements are set between high and low market prices at fixed percentages. Traders who use this technical analysis tool commonly set their price targets using the retracement percentages. They are also commonly used for stop-loss levels and entry levels. These levels are static as they are based on fixed percentages. Some traders find this easier to work with than constantly fluctuating indicators like simple or exponential moving averages.
Applying Fibonacci Retracements to Your Day Trading Strategies
When using Fibonacci retracements, a trader needs to have at least one other technical analysis tool to confirm what Fibonacci retracements lead them to suspect in the day trading market. As with other technical indicators, the market is telling you what the market will do next. In the case of Fibonacci retracements, the market high and low are the input from the market and the retracement percentages are predictable levels to which markets tend to move as they fluctuate throughout the day.
Tips for Using Fibonacci Retracements in Day Trading
Day traders who use this tool typically start by looking at the numbers on a long term chart first. Draw the lines on a weekly chart to establish key levels. Then, go to the daily chart to look at retracement levels and only then go to intraday retracement levels. Indicators most often used along with Fibonacci retracements include Bollinger Bands, moving averages, and the Parabolic SAR. Using trend indicators along with Fibonacci retracements is also a common practice. This having been said, when Fibonacci retracements work they can be right on the money. However, they can be dead wrong as well. Thus, you should never use this indicator alone.
Common Mistakes When Using Fibonacci Retracements
Fibonacci retracements can produce amazing day trading results from time to time. And then they can be totally misleading in other situations. A common mistake when using Fibonacci retracements is to think that this day trading tool is the answer to every trading situation. Another mistake is to think that you never need to pay attention to what is happening in the outside world that is driving the market. The most dangerous mistake is to forego discipline in entering, managing, and exiting your day trades based on a single technical tool.
Examples of How to Use Fibonacci Retracements in Day Trading
An example of how Fibonacci retracements come in handy in day trading is this. You are trading during a day when prices are rising substantially and then they fall. You see that the price drop from the peak matches a 61.8% Fibonacci retracement. As the price rises again you realize that if this is indeed a Fibonacci-related event the price will likely continue to rise as the recent bottom was probably the new resistance level. Traders still need to set and reset their stop loss and take profit levels. However this cue can be a profitable guide as the market progresses.