We will be using Fibonacci ratios a lot in our trading so it’s important to understand and learn them. Fibonacci is a huge subject and there are many different studies of Fibonacci, however, we’re going to focus on the two:

Retracements and Extensions

Let us start by talking who Fibonacci was.

Leonard Fibonacci, also known as Leonardo of Pisa, was a famous Italian mathematician who discovered a simple series of numbers that created ratios describing the natural proportions of things in the universe.

The sequence of the Fibonacci numbers is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377 … to infinity. Starting with zero and adding 1 begins the series. The calculation takes the sum of the two numbers and adds it to the following number

After the first few numbers in the sequence, if you calculate the former by the latter number to that of the next higher number you’ll get .618. For example, 55 divided by 89 equals 0.618.

This is called the golden ratio or golden mean. If we reverse the procedure and divide the latter by the former, we get  1.61804. These numbers are reciprocals.

Fibonacci Retracement Levels

0.382, 0.500, 0.618, 0.786

Fibonacci Extension Levels

1.272, 1.414, 1.618

We use Fibonacci retracement levels to find predictive areas of support and resistance. Since so many traders watch these same levels and place buy or sell orders on them to enter trades, the support and resistance levels become areas of typical reversal.

We also use the Fibonacci extension levels as profit taking levels and to find predictive price movement. Again, since so many traders are watching these levels and placing buy and sell orders to take profits, this strategy typically works for determining expected price movement.