Almost 1000 years ago, an Italian mathematician from Pisa, Leonardo Pisano Bogollo, also known as Fibonacci, created his extremely simple numerical sequence called the Fibonacci sequence. The mathematician certainly did not expect that it would fascinate scientists, researchers, and people from all walks of life even today. 

Wondering what is the use of the Fibonacci series in the technical analysis of digital assets? This lesson covers exactly the same. The major application of the Fibonacci sequence called Fibonacci retracement levels is used to predict the market movements. You can find when to enter new positions in the trend direction by using this technique while trading. 

This lesson explains the importance of Fibonacci retracements in technical analysis.

Contents  

• What is the Fibonacci sequence?
• The Golden Ratio and Fibonacci coefficients 
• What are Fibonacci retracement levels?

What is the Fibonacci sequence?

Basically, the Fibonacci series begins from ‘0’ and ‘1’ and the subsequent numbers are the sum of the previous two numbers. So the series is - 0,1,1,2,3,5,8,13,21,34,......It can extend to infinity. 

Fibonacci numbers come in a natural way and can be found in nature. The number of petals of flowers, growth points of plants, and pineapple scales follow the Fibonacci sequence. There are many interesting properties to the Fibonacci sequence due to which this unique number sequence has applications in coding, cryptography, quantum mechanics, high energy physical science, and the financial markets. 

The golden ratio and Fibonacci coefficients 

When you divide any number in the Fibonacci sequence by its previous number, the ratio is always around 1.618. This is called the "golden ratio" or golden number or Phi. 

Similar to the Fibonacci numbers, the golden ratio is also present in nature like in the human face, animal bodies, rock formation, galaxy formation, etc. You can find more examples of the golden ratio by searching on the internet. It also allows you to draw a logarithmic spiral, the proportions of which we find in nature, art, science, and, as it turns out, also in the case of financial markets.

If we perform more divisions between different numbers like dividing a Fibonacci number by its immediate succeeding number or by a number two places higher or three places higher, we can obtain Fibonacci coefficients.  

We will not delve deep into the theoretical methods of calculating individual coefficients here. The main thing you need to know is that the Fibonacci coefficients are derived from operations performed on successive numbers in the Fibonacci sequence and on the "golden number" (phi). Traders and investors use the Fibonacci coefficients in the Fibonacci retracement method to analyze the charts. Technical analysis software typically uses the most popular Fibonacci coefficients which are 0.236, 0.382, 0.5, 0.618, 0.786, 1.618, 2.618, and 4.236.

What are Fibonacci retracement levels? 

The Fibonacci coefficients are used to conduct analysis on the charts in terms of time changes, price changes as well as time-price changes. One of the simplest and the most popular applications of Fibonacci ratios and coefficients is Fibonacci retracements. 

Retracement levels are the reversal levels at which the price begins to move in the opposite direction (e.g. due to a correction or return to the right trend). By identifying the retracement levels, you can know when to enter the trade. Very often, the Fibonacci retracement levels are represented as percentages like 0.236 is 23.6%, 0.382 is 38.2% and 0.5 is 50%, etc. Typically, investors focus on these levels as they indicate potential reversal patterns. While Fibonacci retracements can be used to place entry orders, determine stop-loss levels, or set price targets; you should not rely on these levels exclusively. There is no guarantee that the price will always reverse just after hitting a specific Fibonacci level. 

Let’s take a look at the Fibonacci retracement levels in the chart below.



 

You need to know that using the Fibonacci retracements in analysis and trading will require a lot of patience and consistency. If you would like to use this method then try using other techniques as well that allow you to determine support and resistance levels. We will be covering more on support and resistance levels in the next lesson. 

In order to use Fibonacci retracements effectively, it is worth knowing the rules of price behavior and its movements on the chart in advance. By combining different skills and tools in technical analysis, you can increase the effectiveness of your analysis and give yourself a better chance of earning profits.