Fibonacci Retracement, Extension and Projections are one of the most popular technical analysis tools in the arsenal of any traders. Infact, Fibonacci Retracements are widely used by day traders and swing traders in their trade setups. These are considered to be leading indicators unlike most of the other technical analysis indicators that are considered as lagging in nature.
Most of us as traders are familiar with the Fibonacci Number Sequence that is obtained by adding the last two numbers to get the subsequent number in the sequence that starts from 0,1. So, the Fibonacci Sequence develops like this 0,1,1,2,3,5,8,13,21,34,55,89,….and so on. These ratios 0.382, 0.5,0.681,1,1.272 and 1.618 are considered to be very important in forming the different retracement, correction, extension and projection levels.
In any trend, price action has the tendency of pulling back or retracing itself. This is also known as the Correction. Suppose, we have an uptrend. The price action when it starts from the low, at some point will tend to consolidate itself by retracing itself or pulling back upto a certain extent and then resuming in the original direction. These retracements or correction can be 0.382, 0.5 or 0.618 percent most of the time. So if you have failed to enter the uptrend at its low, you can enter it at one of these levels.
However, sometimes, price action can continue to retrace itself more than 100% meaning it can go beyond the original low of the trend. When this happens, it is known as a Fibonacci Extension. So, Fibonacci Extension is a special type of correction or retracement when the price action retraces itself more than 100%. This extension can go as high as 1.272 or 1.618 percent.
Fibonacci Projection is a concept that is used to determine the levels where the trend is most likely to exhaust itself. Fibonacci Projections are considered to by very important in the Elliot Wave Analysis. This projection can be at 1.618, 2.618 or even 3.618 percent and is used to determine the swing.
Now, Pivot Point is calculated by adding the High, Low and the Open of a certain timeframe then dividing it by 3. You can calculate two pivot point support levels and two pivot point resistance levels. If you are not familiar with pivot point calculations, you should read my article on Pivot Points.
When you trade with pivot points, you draw these support and resistance levels on the chart and see if the price action breaks these support or resistance or holds it. Suppose, you are trading the 30 minutes chart. You draw the pivot point support and resistance level. The price action rises and hits the resistance forming a doji. A doji is considered to be an indecision bar.
Now, it the price action starts to fall subsequently, you can take it as sell signal with the stop placed close to the high of the doji. When to get out? You can draw the retracement levels 0.382,0.5 and the 0.618 to see where the price action will complete the retracement. This way you can keep your emotional control and don’t let the trade end prematurely. Whatever, Fibonacci Retracement when combined with Pivot Points can be a powerful combination that you should master. Good Luck!