Trading Fibonacci retracement and extension levels
14 Nov 2020
The basic idea behind trading Fibonacci retracement levels is to buy on a retracement at one of the key Fibonacci support levels when the market is trending up, and vice versa.
Introduced by an Italian mathematician, Fibonacci ratios are a sequence of numbers where each number in the row represents the sum of the 2 previous numbers. Derived from the mathematical relationships between numbers in this sequence, Fibonacci ratios are used in crypto trading to determine the support and resistance levels of a pullback. Key retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. As a rule of thumb, the stronger the initial trend, the milder the retracement.
Next to retracements, crypto traders also look at extension levels to calculate where the price may be heading once the support or resistance level is broken.
Trading Fibonacci retracement levels
The basic idea behind trading Fibonacci retracement levels is to buy on a retracement at one of the key Fibonacci support levels when the market is trending up, and vice versa. This crypto trading strategy is known as “riding the trend”, as the price retraces to a previous price level before resuming in the direction of the initial trend.
The first step to identifying retracement levels is to find both a recent significant swing high and a swing low. With most charting tools on crypto exchanges, you will be able to draw the Fibonacci retracement indicator by connecting the swing low to a swing high.
Using the Fibonacci indicator, you are expecting the price to rotate back lower after a swing high is in place, to partially return some of its gains. Eventually, the price will start moving higher again. Finding the right moments to buy and sell depends on your crypto trading style. Identify one of the three levels to play against, with 38.2% being the most aggressive option and 61.8% the safest.
Trading Fibonacci extension levels
With Fibonacci extension levels, we are trying to identify the next levels of support or resistance once the main support or resistance is broken. When you apply this view on the price charts, you are looking at different elements of the price action than what we described under Fibonacci retracement levels.
Here, we look at what happens once the major support or resistance levels are broken, as that breach usually means we’ll see a strong move back to the initial direction of the trend. To calculate the next level of support once a support level is broken, we use the same swing lows and highs.
The major levels to look for are 161.8% and 127.2% and where the former acts as a major extension level and the latter is used as the first station to which the price heads following the breach of the initial support or resistance.
Fibonacci extension levels are generally traded in two ways:
- Use extensions as a potential bounce zone to initiate buy and sell orders against this level looking for a rebound.
- Once the major support is broken, Ride the Trend and place take profit orders just before the 127.2% extension level.
Are you ready to put your skills to the test?
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