39# Fibonacci Retracements, Fibonacci extensions, Fibonacci Levels:Tutorial
Fibonacci: Levels,Retracements, Extensions
Submit by Janus Trader 15/08/2012
A retracement is a pullback within the context of a trend.
After a rise from 0 to 1, short term market participants start to take profit. This drives the price lower until such a point that the bulls, sensing the price is better value, enterthe market again at point 2 and hence “Buy the Dip” enabling the market to continue in the direction of the trend.
Conversely, after a fall from 0 to 1, the shorts take profits thus causing a brief rally
taking the price higher until point 2. At point 2, fresh shorts enter the market
overcoming the shorter term bulls and driving the price lower in the direction of the
Hence the term “Sell on Rally”.
The most popular type of retracement used in the Forex market is, undoubtedly, the
61.2% and 78.6%.
Notice how the downleg retraces 61.8% of the first upleg, 1.2970-1.3470, before
continuing with the trend upwards.
In general, the larger retracements are found at the start and end of a trend as the
market is deciding whether or not the previous trend has finished, maybe ranging a
little before starting the next trend. Once more and more market participants realisethat a new trend is in place, the retracements of the previous leg become smaller in depth with 38.2% and 50% being the most common. As the trend appears to run outof steam, the market becomes undecided and starts to take profit thus causing a deeper retracement of the previous leg eg. 61.8% or 78.6%
In a trending market, the shallower the retracement the stronger the trend.
Extensions are used to project where a price may go to and are useful for calculating target prices when entering a trade
As with retracements, the most popular type of extension used in the Forex market is the Fibonacci extension. The extensions that provide the most commonly used
projections are 61.8%, 100%, 161.8% and 261.8%
How to Use
In the example below, each one of the Fibonacci extensions represents a potential
target when entering a trade. Once a pullback is in place at point 2, we can calculate
the potential targets using Fibonacci extensions. Our initial targets will be 100% at
103.85 and 161.8% at 104.78. Further out our target will be 261.8% at 106.28. The
stronger the trend, the greater the chance that the targets will be achieved.
Combining what we have seen so far:
The one thing that can be said about Technical Analysis is that it is easy to see
everything in hindsight, that is, when it is too late. Let’s look at the above USDJPY
example in more detail, starting from the point where the market is trading sideways, and use the techniques described so far to see how they are applied in preparation for the next move.
Starting with the daily chart so that we have an overall perspective of how the market is biased:
In the pictures Fibonacci Retracements, Fibonacci exstensions, Fibonacci Levels: Tutorial forex system in action.
The blue line represents the long term trendline resistance. The black line represents
the medium term trendline resistance that is currently in play. The red line is the
previous medium term trendline support, the break of which initiated the current down trend. Notice the pullback on 12 and 13 October, after the initial breach of the red trendline support, confirming that it now acts as resistance. We can also see that the market has been trading sideways in a range since the 24 November.
Let’s apply some of the techniques in retrospect to see how the market behaved and
to obtain a feel for what we should expect about the current market level. The chart
below is the above chart after applying Fibonacci retracement and extension
calculations plus a support line.
First thing to notice is that point 2 is a retracement of approximately 78.6% of leg 0-1
indicating to us that we may have the base of another trend.
Secondly, by plotting the Fibonacci extensions of the leg 0-1 we see some interesting
results, namely that at each of the extensions there is a pause or turning point. This
indicates that perhaps the market has been using this series of extensions as targets
and taking profits when reached.
Thirdly, we see that the 24 June support at 107.00 acted as a resistance zone for the
pullback of 10 November.
Fourthly, and perhaps of the most interest given the current scenario, we see that
recent price action has pulled back from the 261.8% extension at 101.99 and has
ranged since reaching that level. Recent price action at this level may prove to be
consolidative before moving lower or may be an early indication that a retracement is due.
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Fibonacci Forex strategies
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