The mention of the term Fibonacci may induce some flashbacks to around the eighth grade for many of us. Particularly to a specific rabbit population sequence. If this sounds vague, don’t worry. The Fibonacci series is a fairly simple set of numbers (1,1,2,3,5,8,13,21……) where each term can be arrived upon by adding its immediate two predecessors.If you’re wondering what any of this has got to do with trading though, particularly crypto futures, read on.
Fibonacci Series: The Numbers To Look Out For
The Fibonacci series of numbers is widely attributed to Leonardo Bonucci, nicknamed Fibonacci. The rabbit problem mentioned earlier was actually a part of his book, called Liber Abaci, where he theorised the growth rate of a set of rabbits under specific conditions to follow the aforementioned pattern. Each number in this series is roughly 1.618 times greater than the previous ones, giving rise to the first important number useful for trading (0.618). Similarly, another important number which is obtained using this series, 0.382, is obtained by dividing a number with another number that is placed two places to its right.
While the numbers may seem like they are vague now, understand that these are all taken by using some formula or the other from within the Fibonacci series. This approach has historically proven to be useful as a great tool while trading any financial instrument, crypto or otherwise.
The most important numbers to look out for are 38.2%, 50%, 61.8% and 100% for trading in cryptocurrencies.
Concepts To Understand
Before we delve into how the Fibonacci numbers are used in trading, you need to have a basic understanding of what comprises swing trading, and other basics like resistance levels and support levels. These are prerequisites to truly understanding the magic of the Fibonacci numbers. If you already understand these concepts, skip ahead to the next section where we discuss the theory behind Fibonacci retracement.
#1 Swing Trading
Swing trading is the type of trading approach wherein the traders attempt to capture short-medium term gains on a financial instrument. They do this by predicting the changes in prices over time with the help of technical analysis tools, like the Fibonacci Retracement. In fact, a significant portion of swing traders relies exclusively upon technical analysis to determine their position. A significant difference between day-trading and swing trading is the fact that most trades aren’t carried out intra-day, but take place over the course of a few days, or weeks. They usually operate within a risk-reward ratio, trying to minimise the potential losses, while gathering a chunk of money if the instrument moves as predicted, before moving on to the next trade.
#2 Resistance & Support
Technical analysis relies on chart patterns, to predict how a particular asset might move over time. Now consider the following graph.
This graph exhibits a downward movement in the instrument’s price, over a period of months. However, albeit being in a downward trend, the price doesn’t fall beneath the $51.25 mark, as the selling momentum loses the steam there, and buyers take over to drive up the price. Not that the price will never go beneath the $51.25 mark, but it is difficult for the sellers to rally beyond that point and push the price further down.
Now consider this graph.
This chart showcases the movement in the price of Bank of New York Mellon Corp stock in 2010. As highlighted by the yellow line, you could see that it had a tough time going above the $26.5 mark, and on multiple occasions, it drops to a lower level. This phenomenon is called the resistance barrier, where the buyers will eventually lose steam and cannot drive the prices up any longer. Resistance is the opposite end of the spectrum when compared to support.
One common trend that you observe over time is that resistance and support levels aren’t usually broken, but when they are broken, the broken barrier switches behaviours. For instance, in the graph, notice how once the resistance broke around November, the prices didn’t fall back below the $26.5 mark. This is because, once a resistance line is broken, they tend to be the support after it’s broken and vice versa.
Fibonacci Retracement: The Theory
Now that we have understood the basics of trading, let’s get into the crux of this post: Fibonacci retracement in crypto trading:
- In the graphs, notice how after each upward movement, the market swings downwards a little before going back up again? This phenomenon is called retracement, where there is a temporary reversal of an overarching trend.
- The markets usually retrace in the percentages of 38.2, 50 or 61.8 – which are derived from the ratios we find in the Fibonacci sequence discussed earlier.
- While 50% is not a Fibonacci Retracement number, we also include it in the list of numbers to look out for. We do this because Dow Theory suggests that after an impulse move, the markets have a tendency to fall back to half the prior movement. More on the Dow Theory, in a separate post.
- More often than not, either of these three numbers forms the support line for the retracement in an upward trend and the resistance in a bearish market.
Authentic Examples of Fibonacci in Practical Situations
This chart from the Litecoin-Bitcoin pair is a wonderful real-life example of how the Fibonacci numbers act as supports and resistance during a retracement. Let’s take a closer look to understand Fibonacci retracement in crypto better.
- You can see how after a market rally, a retrace occurred, and how the retrace always seems to end at one Fibonacci number or the other.
- You can see how the 0% line acts as a resistance, while one of the Fibonacci numbers tends to act as the support during this market movement.
- The retrace culminates at the 61.8% point, which traders take as a buy signal, pushing the prices higher back up to nearly the original resistance point – the 0% line.
Now, how do we calculate the retracement numbers? For the sake of simplicity, let’s put away the highly fractionalised numbers in the above graph and consider Bitcoin at $8,000. Say it rises to $13,000 in a rapid rally. Now, these two price levels will be the points we rely on to identify our support lines. Now, a 38.2% retracement level will be at $13.82 ($13,000 – ($5,000 x 0.382) = $11,090).
Extending this example to understand Fibonacci retracement in cryptocurrencies – in the LTC/BTC pair above, the 38.2% retracement level would be calculated by (0.02100407-(0.02100407-0.00301306)*.382 = 0.01413150).
It is easy to use Fibonacci Retracement as a tool, especially since it is handily available in many charting tools and exchanges, such as Delta. As a trader, you:
- Set the swing high and the swing low (the highest point of a previous significant movement, and the lowest point of the same movement), to identify the horizontal lines denoted by the Fibonacci numbers. These lines usually tend to be a support line in case of an overall upward trend and a resistance in an overall downward trend.
- Using these lines, in confluence with other tools, ensure that you can time your entry and position in the market appropriately and reap the rewards of a successful entry.
However, it is essential to understand that while these tools help to “predict” the market with a certain level of accuracy, no technical analysis is foolproof. After all, markets are always subject to a variety of micro and macro factors. In other words, it is impossible to see precisely how the market will react over time, though such tools do help to an extent. Do make sure you are comfortable with those risks before making a sizable investment. If you’re looking to begin your crypto derivatives journey with Bitcoin Futures, here’s a guide.