Fibonacci Analysis – Basic Trading With Fibonacci Retracements and Extensions
Fibonacci analysis has become an essential tool to the modern trader. Some traders may be skeptical regarding the unique and slightly abstract way Fibonacci retracements and extensions analyze the market but ultimately all a trader needs to be aware of is whether they are reliable and accurate.
The resounding answer to this question is yes and this is why Fibonacci analysis has become one of the most popular indicators available to traders. The principle use of Fibonacci retracements and extensions is to project strong lines of resistance and support for a security. Armed with these indications a trader can employ a basic but often successful trading technique by placing pending entries into the market.
The Fibonacci sequence should technically have no effect on the world of trading but it does. This is largely believed to be because so many traders use Fibonacci analysis that they abide by the projections it makes.
This causes the large majority of traders to make decisions based on the evidence presented by the Fibonacci retracements and extensions and as a consequence the market will move in the direction suggested by the analysis.
Essentially traders all over the world are following the rules laid out by the Fibonacci analysis and this causes the market to move in the predicted directions anyway and this makes the Fibonacci analysis a form of self-fulfilling prophecy.
The reasons behind the accuracy and reliability of Fibonacci retracements and extensions is largely irrelevant because all a trader needs to do is have faith and rely on the consistent and dependable history of the Fibonacci indicator.
One could subscribe to that belief but the truth is, even very old price charts reveal an amazingly accurate Fibonacci relationship.
When deployed properly the Fibonacci retracements and extensions predict significant lines of support and resistance of any security being analyzed. The retracements and extensions are laid over the top of a candlestick chart and if done accurately the resistance and support can be clearly seen. The price of a security is likely to either rebound when it hits one of these lines or pass it and if it breaks the support or resistance it is likely to keep on going. This is valuable knowledge for a trader and with a basic technique large profits can be made by playing the market with this information.
If a trader is analyzing the current price of a security they can use the resistance and support lines, as projected by the Fibonacci analysis, to form a number of market tactics.
For example if there is a strong line of support a trader should place pending buy with the intention that the price hits that buy and rebounds and makes profit. If the price breaks the support a trader should place a stop loss to ensure that no significant amounts of money are lost.
Alternatively a trader could place a pending buy above a resistance line. This could ensure that if the price breaks the resistance the buy will be triggered and it is likely the price will keep on rising. There are a number of similar variations to this technique a trader can take advantage of with Fibonacci analysis.
By: Mark Deaton
