Last Updated on December 15, 2022
There are many indicators and tools for technical analysis, but only a few have leading properties like the Fibonacci tools, which is why Fibonacci trading is popular among traders. But how do you trade a Fibonacci trading strategy?
A Fibonacci trading strategy is the use of Fibonacci tools in making a technical analysis of a security price. The popular Fibonacci tools include the Fibonacci retracement tool, the Fibonacci expansion tool, and the Fibonacci fan.
These tools are used to indicate where support and resistance are likely to occur on the chart, which helps a trader to plan his trade entry and exit accordingly.
In this post, we take a look at Fibonacci tools and how to use them. At the end of the article, we provide you with some backtested Fibonacci trading strategies.
What is Fibonacci trading?
Fibonacci trading is the use of Fibonacci tools in making technical analyses. The popular Fibonacci tools include the Fibonacci retracement tool, the Fibonacci expansion tool, the Fibonacci fan, the Fibonacci channel, and so on. These tools are used to indicate where support and resistance are likely to occur on the chart, which helps a trader to plan his trade entry and exit accordingly.
Not only can the tools be used to predict potential support and resistance levels in the market, but they also mark these levels before the market gets there. In other words, they lead the price, unlike moving averages and other indicators that lag the price. With this remarkable property, traders can anticipate what will happen ahead of time so that they can plan what to do.
Using Fibonacci in trading allows traders to analyze the market and plan for their trades ahead of time. Knowing the important reversal areas, a trader can decide when to open or close a trading position, as well as where to place stops and limits to their trades.
Let’s take a look at a few of the Fibonacci tools.
The Fibonacci retracement tool is used to the percentage of the previous price swing the price can retrace before it reverses to continue in the direction of the trend.
When plotted on the price chart, the Fibonacci retracement tool draws horizontal lines at 23.6%, 38.2%, 50%, 61.8%, 100%, and so on of the preceding price swing to indicate potential support/resistance levels where a pullback may get to before reversing. Traders use these levels in their trading strategies to determine their entry point and stop loss levels.
Fibonacci expansion tool
The expansion tool traces the pullback swing and uses the size of the pullback to estimate how far the next impulse swing can expand in the trend direction. Since the tool calculates from the end of the pullback, a 100% expansion level implies that the next price swing would be the same size as the preceding one. The expansion levels can be used to estimate profit targets.
As the name implies, it fans out a series of trendlines at various Fibonacci levels, which may represent dynamic support and resistance levels. In an uptrend, the trendlines represent ascending support or resistance levels.
See the chart below:
How to attach the Fibonacci retracement tool to your chart
To use the Fibonacci tool, you have to properly attach it to the right price swing. Let’s show you an example with the retracement tool. Follow these steps when attaching the tool to your chart:
- First, find out the trend direction
- Identify the most recent impulse swing when the price has started pulling back
- Pick the Fibonacci retracement tool on your charting platform and attach it to that most recent impulse swing from where it began. So, if it is an upswing in an uptrend, you start from the low to the high, but if you are dealing with a downswing in a downtrend, you start from the high to the low.
- Select the side you want the retracement levels’ values written – left or right. The tool will display horizontal lines marking the percentage retracement of that impulse swing, such that the beginning of that impulse swing would bear a 100% retracement level.
The Fibonacci retracement tool in a downtrend.
How Fibonacci levels are used in trading
There are different ways traders use Fibonacci tools in their trading, but these are the three common ways:
- Trade entry: Since the Fibonacci retracement levels show some areas of interest to watch when the price is making a pullback, traders start looking for trade signals around such levels. For example, if the RSI is showing an oversold/overbought condition when the price gets to a retracement level, such as the 61.8% level, it may be a good signal to enter a position. Price action traders look for reversal candlestick patterns, such as the pin bar or engulfing pattern, at that level. Some traders may even place limit orders at the Fibonacci levels, but this practice is risky.
- Stop loss level: Traders also use Fibonacci retracement levels to know where to place their stop loss orders. One commonly used method is to place the stop loss order beyond the 100% retracement level if the trade entry is around the 50% or 60% retracement level.
- Profit target level: Many traders use the Fibonacci expansion levels, especially the 100% expansion level, to estimate their profit targets. For those who like taking partial profits at multiple levels, the 100%, 161.8%, and 261.8% expansion levels may be good for partial profit targets.
Which time frame is best for Fibonacci trading?
There is no best timeframe for using the Fibonacci tools in trading. The timeframe you choose depends on your trading style. If you are a day trader, you may have to use intraday timeframes. A swing trader would use the daily or 4-hourly timeframe.
Nevertheless, most technical analysis methods work better on higher timeframes, especially the daily timeframe. But the only way to know the best timeframe for your Fibonacci trading strategy is by backtesting it.
What are the best Fibonacci levels?
Various Fibonacci levels work differently in different markets. Sometimes, it depends on the market volatility. If there is little volatility, pullbacks may be short and end around the 23.6% or 38.2% levels. In markets with high volatility, pullbacks can get up to 61.8% and beyond.
Having said that, many traders prefer 50%-61.8% levels. But the only way to know the best retracement levels for your trading is from backtesting.
Is Fibonacci a good trading strategy?
There are traders who have used the Fibonacci tools in their trading strategies to great success. As a matter of fact, many traders swear to to using Fibonacci levels as the holy grail of trading.
Will Fibonacci be a good strategy for you?
No one knows; you alone can find out. The only way to find out without risking your money is to backtest the strategy and further trade it on a demo account.
- Backtesting – 28 Facts About Historical Testing Every Trader Should Know
- Why backtest a trading strategy
Fibonacci trading strategy (backtest) – does it work?
When we search on the internet about Fibonacci strategies, we are met with headlines like these:
- Fibonacci Retracement — A Powerful Strategy For Consistent Profits
- Fibonacci Techniques for Profitable Trading
- How to Trade with Fibonacci
Yet, all of them are based on anecdotal evidence and no proof whatsoever that this is a viable strategy.
To our knowledge, Fibonacci traders don’t use backtesting at all, despite many academic research papers claiming there is absolutely no scientific evidence as to why prices should follow Fibonacci numbers.
That said, using Fibonacci numbers to find support and resistance might be a different matter, though, including stop and exit levels.
We were trying to backtest several Fibonacci trading strategies based on retracements and fans but decided to stop because we found out we were not able to make meaningful backtests. Any backtest requires strict trading rules and some additional settings, but because this is a somewhat subjective pattern, we are not able to jot down what is needed and it’s not worth the time, in our opinion. It’s simply too many rules that are needed.
Instead, let’s summarize one of the very few findings on the internet about backtested Fibonacci trading strategies.
We came across a backtest and dissertation paper by Clarissa Gunawan called Fibonacci Retracement Trading Strategy and Backtesting. Her study aimed to test the validity of using Fibonacci and optimize it by using other indicators. The market she looked at was several Vanguard ETFs. We quote the conclusion:
The passive trading strategy outperforms the active trading strategy using Fibonacci retracements, as evidenced by the higher buy and hold return and CAGR compared to the active trading strategy’s net profit and CAGR. This might signal that Fibonacci retracements might not be a very good technical analysis tool. After all, there is no scientific evidence as to why prices tend to follow the Fibonacci numbers. However, the Fibonacci retracement is still very useful in determining the levels of support and resistance, and also a good way for traders to mark their target profit. Thus, traders should use the Fibonacci retracement tools with caution and should use it in combination with other indicators to verify the trades.
Clarissa Gunawan used Fibonacci and coupled it with moving average crossovers, the RSI indicator, and the ATR indicator. And as the quote above indicates, the statistics, metrics, and performance suggest it doesn’t.
To sum up, we believe you’re better off using other strategies. We have written plenty of other trading ideas:
List of trading strategies
Since this blog’s inception back in 2012, we have written more than 800 articles. Many of those articles contain strategies (including this article), and we have compiled many of those into a package of code that you can order. We have thus far over 160 different strategies in our compilation.
The strategies also come with logic in plain English (plain English is for Python trading strategy).
For a list of the strategies we have made please click on the green banner:
These strategies must not be misunderstood for the premium strategies that we charge a fee for:
FAQ Fibonacci trading
Fibonacci tradingis popular despite the lack of evidence. Below we have some short answers on our take on Fibonacci numbers and trading:
Q. What is Fibonacci trading?
A. Fibonacci trading is a trading strategy that uses Fibonacci ratios to identify potential support and resistance levels. Fibonacci ratios are derived from the Fibonacci sequence, which is a sequence of numbers where each number is the sum of the two preceding numbers. Fibonacci ratios are used to identify areas where price levels may reverse or consolidate before continuing the current trend.
Q. How do I use Fibonacci trading?
A. Fibonacci trading can be used in both short and long term trading strategies. The most common way to use Fibonacci trading is to identify potential support and resistance levels by applying Fibonacci ratios to the price chart. For example, you can use the ratios to identify potential reversal points (support and resistance) by looking for areas where the price has retraced a certain percentage of its previous move.
Q. What are the most common Fibonacci ratios used in trading?
A. The most common Fibonacci ratios used in trading are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. These ratios are derived from the Fibonacci sequence of numbers and are used to identify potential support and resistance levels. These ratios can be used to identify areas where the price may reverse or consolidate before continuing its current trend.
Q. What is a Fibonacci retracement?
A. A Fibonacci retracement is a trading tool used to identify potential support and resistance levels. A Fibonacci retracement is created by drawing a line from a peak to a trough on a price chart and then dividing the vertical distance between the peak and the trough by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 78.6%. These ratios are used to identify areas where the price may reverse or consolidate before continuing its current trend.
Q. Does Fibonacci work in trading?
A. Most likely not. Hardly anuthing is backtested. We recommend NOT using anything that is not backtested.
Q. How successful is Fibonacci trading?
A. The believers claim it’s very successful but critics (like we are) have yet to see any rich Fibonacci trader (and we have not seen any successful backtests).
Q. Is Fibonacci good for crypto?
A. As we have indicated earlier, probably not (but we have not backtested). Show us a positive crypto Fibonacci backtest, and we’ll start using it ASAP.
Q. What time frame is best for Fibonacci?
A. There is no best or worst in trading. If it works, it works, so also for Fibnonacci. The only way to find out if something works or not, is to backtest.
Q. Is Fibonacci good for day trading?
A. We were porpritary day traders for 18 years, and during our career we didn’t see anyone using Fibonacci numbers (probably for a good reason!). So the answer is probably no.