HQ Webinar

What Is Fibonacci Trading?

In this monthly special technical analysis feature, CMC Markets will bring you trading guides and strategies to help you develop and enhance your trading skills.

Fibonacci retracements are a popular form of technical analysis used by traders to predict future potential price support and resistance levels in the markets.

If used correctly, Fibonacci trends can help you identify upcoming support and resistance levels based on past price action.

Leonardo Fibonacci was a mathematician born in 1170 AD. From his work, we get the Fibonacci sequence of numbers, and also the golden ratio. The Fibonacci sequence is a series of numbers where the next number is simply the sum of the two preceding numbers. So, for example, it would run 1, 1, 2, 3, 5, 8, 13, 21, 34, and so on.

It’s based on the rate of reproduction of two theoretical rabbits and the subsequent population growth if the following generations continued to reproduce. At first glance, it may seem somewhat confusing to find there’s a connection between a 12th-century mathematician, the rate at which rabbits reproduce and predicting the future direction of the financial markets using technical analysis. So why is this series of numbers so important for traders?

Fibonacci’s Golden Ratio 

The focus tends to be on the ratio between the numbers in the sequence. It’s this that is considered to be the most important part of Fibonacci’s work. Any number in the series divided by the previous number gives us 1.618 as we get further down the series. This is known as the ‘golden ratio’. For Fibonacci followers, there are plenty of examples in nature adhering to this ratio (or the inverse of the number, 0.618). It seems to have played an enormous part in the building blocks of everything around us.

For example, if you divide the number of female bees by male bees in a hive you will get 1.618 as the answer. For sunflowers, each new seed is 0.618 of a turn from the last one. Fibonacci also applies to humans as well. There are lots of instances of this golden ratio working on our bodies: just one example is the ratio of the length of your forearm to your hand: 1.618.

Fibonacci Retracement Levels

The argument of Fibonacci followers is: if so much of nature and the world is made up of these Fibonacci ratios, surely the same would apply to the markets too? One way in which analysts use this approach is through Fibonacci retracements. Let’s say for example that a market has risen and, like all markets, it doesn’t move in a straight line and starts to fall back. Traders will look at Fibonacci ratios to try and figure out where the fall may stop and the market will resume its previous rise.

What Is The Fibonacci Sequence?

The golden ratio of 1.618 – that magic number – gets translated into three percentages: 23.6%, 38.2% and 61.8%. These are the three most popular percentages, although some traders will also look at the 50% and 76.4% levels. 50% is not a Fibonacci number, but has proved to be a generally popular number when correcting a primary or secondary price move. For now we will focus on the 50% and the two more popular Fibonacci percentages of 38.2% and 61.8%.

These are then applied to the chart to try and figure out potential hidden levels of support or resistance in the market. When the market drops back to 38.2% of its previous rise (the first major Fibonacci retracement), traders will check to see if any buyers come in. If this 38.2% level gets broken, then the expectation is for the 50% retracement to be the next target. If the market slides through that 50% retracement level, then traders will look to see if the market finally stops its decline when it has retraced 61.8% of the prior move. For most Fibonacci followers, if it breaks through that 61.8% level it means the market is going back to where it started.

We can create Fibonacci retracements by taking a peak and trough (or two extreme points) on a chart and dividing the vertical distance by the above key Fibonacci ratios. Once these levels are identified, horizontal lines can be drawn and then used to identify possible support and resistance levels.

An Example Of The Fibonacci Pattern

This example shows the rise in the price of Crude Oil West Texas (also called WTI Crude Oil). The market then stalls, making it possible for traders to apply some Fibonacci retracements to that rally, to see where support comes in. As can be seen, the price does slide back but although briefly probing through, the 38.2% retracement in the $35 area does end up providing some support.  The market rebounds and moves out to fresh highs for the recovery.

Trading Falling Markets

Fibonacci doesn’t just apply to rising markets. If a market has fallen then Fibonacci fans will apply the retracements to the bounce back up. Let’s take an example of a market that has dropped 100 points. If it rallies 38.2% then those looking at Fibonacci retracements will expect the rally to run out of steam. If that level is broken then the 50% level is where traders would look for the market to turn back down. And finally, if that one gets broken then a 61.8% retracement of the down move is the next target, with a break here suggesting the market will go all the way back to where it started the fall.

The next chart shows the drop in GBP/USD. The currency pair fell from the 1.5200 area to 1.4100, before stabilising. As the market stabilised, Fibonacci retracements could be applied to this fall. It can be seen that when the market had bounced back by 50%, the recovery ran out of steam and the slide resumed. This is an example of a Fibonacci retracement helping us to figure out when to sell short in a downtrend.

Not everyone is a fan of the Fibonacci approach to market analysis. Some just see the levels as a self-fulfilling prophecy as so many people are watching them, and not having any particular ‘magical’ properties. But even for the sceptic, it can give an extra level of insight into potential market turning points that may not be clear at first glance.

Visit:  Fibonacci Quantum

Day Trading Your Way To Financial Freedom

Financial freedom means different things to different people. But, at its core, it is about the ability to make choices that you otherwise would not be able to make. Haven’t you heard that old age old question, “What would you do if you had a million dollars?” Granted, the amount hasn’t increased since the theoretical question was first invented. We might be better off asking what one would do if they had ten million dollars, but you get the point. It’s supposed to illustrate to us what we truly love doing, that is, if money was of no concern. If money and expenses were of no consequence to you, would you still have the same job or career that you do now? While I am sure there are some cases of people who would say yes, I know many others that would most definitely say no.  How do you gain the freedom to say no to work you don’t want to do and yes to the life experiences that matter to you. It is simple: You spend way less than you earn.

Now, there are a couple ways you can do that. You can cut your spending way down, to subsist at a level that allows you to save and invest conservatively while still making that paltry salary the boring cubicle job affords you. Our you could up your skills and earn way more than you spend, by creating a second stream of income, eventually building up that stream of income to eclipse the first, paltry stream. Multiple income streams are a must for anyone eyeing early retirement. You simply need to protect yourself for downturns in the stock market, housing values, sales commissions, or any other type of investment or revenue stream you currently enjoy.

One of the best ways to create that second stream of income is to become a day trader. You can make money off stocks that move up and down during the trading day, but you need to have a coherent strategy, rock-solid risk management instincts and a willingness to study and do research. There are day trading education sites out there that can teach you the strategies and give you a chance to hone your skills in trading chat rooms with veteran day traders and in trading simulators.

Now, it needs to be said that day trading is not a way to get rich quickly. You need to learn your way to competence before you can begin to make even small profits. But that can be a stepping stone to bigger and better things. As with all investments there is inherent risk, so you should only invest to the level that you are comfortable and can afford the cyclical nature of the markets. Investing, and specifically day trading, takes a certain amount of time and discipline to master and get good at.

Veteran day traders can take a small amount of money and build it back up into a real serious pile of cash. After years of learning the market, they can take a couple of months to trade their way to six figures, faster than noobs on the market. That’s why it pays to stick with it even if you hit a rough patch or two to start.

There is a story out there about some serious interactive brokers that funded a trading account with just over $500 and turned it into $100,000 in just 44 trading days. While that may seem like an old wives tale, it is true. I wouldn’t say this is a typical expectation for first timers, but it’s a result that is measurable and achievable, and these are the sorts of guys you want to learn from!

But, in order to do that, to build up a career from scratch that will allow you to be in that category of day trader, you need to really buckle down and do the work. Learning momentum day trading strategies, absorbing risk management lessons and trading on a day to day basis takes a long time. So it helps to have a day trading education site that will support you on this journey to financial freedom.

TradeNet  is a site with a special focus on preparing novice traders for the volatility of the market, day to day. Because volatility is one of the backbones of day trading profitability. Getting on with a stock that sees a 20-30% spike in share price on a given day and getting off before you see that spike go down, is a great way to lock in some profits on a particular day. The key is, with day trading, to do that every day. And to minimize your losses at the same time, so you have a healthy profit/loss ratio at the end of the week or the end of the month.

Part of optimizing your risk management instincts is by trading in simulated environment before going out and risking real money. That is where you can learn how to make trades in real time and make mistakes (and learn from mistakes) before you are risking real money. A paper trading simulator gives you a certain amount of virtual currency and mimics the brokerage account, stock market conditions and technical indicators that allow you to trade like a real day trader, but you can avoid losing your savings.

It is an excellent way to understand how you need to keep your trades in check. For example, if you pick a stock in the morning, put a stop-loss on the trade and it dives, you need to get out when the stop-loss says. You don’t need to stay in with the hopes of a miracle recovery. Cut your losses early and focus on finding the next stock that will help boost your overall profits. That is the sort of lesson that is nice to learn by practicing some virtual day trading. I would say you should spend a few months practicing until you understand the ins and outs of day trading, and to cycle through the learning curve before you start throwing real money into it.

That is how you make your money as a day trader. Not with a big, quick score that shocks the world. With small grinding trades day after day, that are smart and well-researched. You keep your overhead low, your skills sharp and your nose to the grindstone. That is how you day trade your way to financial freedom.