Trading 101 - The Validity of Fibonacci Retracements in Crypto Trading

2021/08/05 10:02:37

In a market ruled by volatility and traders’ sentiment, it’s invaluable to have reliable support and resistance levels. And although most traders would prefer to use price action to draw their support and resistance levels, they tend to be inaccurate most of the time. With Fibonacci Retracement, traders get a powerful predictive tool. With it, you can predict potential support and resistance levels for any timeframe.

What are Fibonacci Retracements?

Fibonacci is an infinite sequence of natural numbers. In crypto trading, the Fibonacci levels are considered the support and resistance levels derived by using the famous number sequence.

Leonardo Pisano Bogolla discovered the Fibonacci sequence. The Italian mathematician discovered a relationship within a sequence of numbers that follows a pattern. The sequence starts at the second number, where each number in the sequence is the sum of the previous two numbers.

For example, 2+1 is equal to 3, and then 5, 8, 13, 21, etc., to infinity. The pattern is also used in financial markets and is a fundamental building block for algorithms. These open or close trades automatically.

If you divide a number in the Fibonacci series by the immediate next number, you get a value close to 0.618 (for example, 8/13 = 0.6154). And if you divide a number by the number after that, the result is always close to 0.382 (for example, 8/21 = 0.381).

Technical analysis takes advantage of this characteristic by assuming that price fluctuations follow the Fibonacci retracements based on the laws discovered by Fibonacci.

Fibonacci Retracement Levels

The Fibonacci retracement is a very popular tool used by many technical traders. It identifies strategic points for transactions to be placed, target prices, or stop losses. After significant price fluctuations, the new support and resistance levels are often at or near these lines. Note that the Fibonacci Retracement Levels are usually static and do not change like moving averages. This allows traders to anticipate and easily identify the support and resistance price points.

Keep in mind that price fluctuation in the crypto market is caused by market sentiment and the forces of supply and demand. Traders pay attention to these levels because there is a lot of liquidity there. The more traders pay attention to these levels, the higher the liquidity will be.

Depending on the strategy, the different lines can be used for resets or targets.

0.236 Retracement

Suitable for high momentum trades. The trend should show high volume. Do not trade against other resistances in the market.

0.382 Retracement

This is a rather less important level. The market will mostly move on to the 0.5 retracement.

0.5 Retracement

It is the most important and effective retracement of the Fibonacci tool. It depicts the average movement. Many algorithms and traders buy at half the price.

0.618 Retracement

When combined with the 0.5 retracement, it forms an effective entry and exit level. The market can oscillate between the 0.382 and 0.618 retracement. It is where optimal pullback trades take place.

0.786 Retracement

It’s one of the least important retracements. The trend is often long gone, and you should not make a pullback trade here. More so, entering the trend won’t be as profitable.

How to Use Fibonacci Retracements in Crypto Trading?

Fibonacci Retracement levels can be used as a buy signal for pullbacks during an uptrend. In a bearish market, the levels can be used for short selling when resistances reject a Fibonacci retracement level. It is advisable to use a momentum indicator such as stochastics or a MACD oscillator to determine the optimal entry and exit levels.

Depending on the market trend, the Fibonacci Retracement levels serve as support and resistance. Typically, there’s always a short pullback at these levels. So, it is wise to wait for the price to breach the levels for the second time before confirming a trend.

The most significant Fibonacci retracement level to look out for is 0.618. It is the reciprocal of the Golden Ratio (1.618). This is where most traders buy or sell, depending on the market trend. This level is often the psychological brand in the market.

In a bullish trend, greed reaches its peak here. However, nervous traders sell their holdings, resulting in a short-term pullback. Bargain hunters pounce back in the market to resume the upward trend.

In the below BTC/USDT price chart, we can see the market accurately respecting all the Fibonacci Retracement levels.

Applying Fib Retracements in an Uptrend on the Bitcoin Price Chart | Source: BTC/USDT

In a bearish trend, fear reaches its peak at the 0.618 level. Nervous short sellers exit their positions, resulting in a short-term pullback. However, the buyers are exhausted, and the sellers push the price down and resume the downward trend. Always wait for the price to break below the 0.618 retracement level to confirm the bearish continuation. The same can be observed in the Bitcoin price chart below.

Applying Fib Retracements in a Downtrend on the Bitcoin Price Chart | Source: BTC/USDT

Bottom Line

Fibonacci Retracements are one of the most versatile tools for any crypto trader in determining the possible entry and exit levels. However, the retracements do not have a 100% probability of a successful trade. Therefore, always confirm their validity by pairing them with other reliable technical indicators or candlestick patterns. Did you find this lesson useful and interesting? Follow the KuCoin blog for more amazing educational content. All the best!

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