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Charts - Fibonacci

There is a special ratio that can be used to describe the proportions of everything from nature's smallest building blocks, such as atoms, to the most advanced patterns in the universe, such as unimaginably large celestial bodies. Nature relies on this innate proportion to maintain balance, but the financial markets also seem to conform to this golden ratio.

Every year new methods are developed for traders to take advantage of the uncanny tendencies of the market toward derivatives of the golden ratio. In this section we will discuss some of the more popular non-mainstream uses of Fibonacci, including extensions, clusters and Gartleys, and we'll take a look at how to use them in conjunction with other patterns and indicators. (For a primer and background on basic Fibonacci techniques, refer to Fibonacci And The Golden Ratio.)

Fibonacci Extensions
Fibonacci extensions are simply ratio-derived extensions beyond the standard 100% Fibonacci retracement level. They are popular as forecasting tools, and they are often used in combination with other technical chart patterns.

Figure 1 below shows a typical implementation of a Fibonacci extension forecast:



Figure 1: An example of how the Fibonacci extension levels of 161.8% and 261.8% act as future areas of support and resistance.
Source: Tradecision


Here we can see that the original points (0-100%) were used to forecast extensions at 161.8% and 261.8%, which served as support and resistance levels in the future.

Many traders use this technique in conjunction with wave-based studies - such as the Elliott Wave or Wolfe Wave - to estimate the height of each wave and more clearly define the different waves. (To learn more about Elliott Waves, see Elliott Wave Theory, and for more information on Wolfe Waves, see Advanced Channeling Patterns: Wolfe Waves And Gartleys.)

Fibonacci extensions are also commonly used with other chart patterns such as the ascending triangle. Once the pattern is identified, a forecast can be created by adding 61.8% of the distance between the upper resistance and the base of the triangle to the entry price. As shown in Figure 2 below, these levels are generally used as strategic places for traders to consider taking profits.



Figure 2: Many traders use the 161.8% Fibonacci extension level as a price target for when a security breaks out of an identified chart pattern.
Source: Tradecision



Fibonacci Clusters
The Fibonacci cluster is a culmination of Fibonacci retracements from various significant highs and lows during a given time period. Each of these Fibonacci levels is then plotted on the "Y" axis (price). Each overlapping retracement level makes a darker shade on the cluster - the darker the cluster is, the more significant the support or resistance level tends to be.



Figure 3: An example of Fibonacci clusters is shown on the right side of the chart. Dark stripes are considered to be more influential levels of support and resistance than light ones. Notice the strong resistance just above the $20 level.
Source: Tradecision



Many traders use clusters as a way to quickly gauge support and resistance levels. A popular technique is to combine a "volume by price" graph on the left side, with a cluster on the right side. This allows you to see which specific Fibonacci areas represent significant levels of support and/or resistance - high-volume and dense cluster areas indicate key support and resistance levels.

This technique can be used in conjunction with other Fibonacci techniques or chart patterns to confirm support and resistance levels. (For other ways of analyzing these levels, see Gauging Support And Resistance With Price By Volume.)

The Gartley Pattern
The Gartley pattern is a less popular pattern combining the "M" and "W" tops and bottoms with various Fibonacci levels. The result is a reliable indicator of future price movements. Figure 4 demonstrates what the Gartley formation looks like.



Figure 4: An example of what bullish and bearish Gartley patterns look like.
Source: www.harmonictrader.com



Gartley patterns are formed using several rules regarding the distances between points:

X to D - Must be 78.6% of the segment range XA
X to B - Must be near 61.8% of the XA segment
B to D - Must be between 127% and 161.8% of the range BC
A to C - Must be 38.2% of segment XA or 88.6% of segment AB

How can these distances be measured? Well, one way is to use Fibonacci retracements and extensions to estimate the points. Many traders also use custom software, which often includes tools developed specifically to identify and trade the Gartley pattern. (You can also download a free Excel-based spreadsheet from ChartSetups.com to calculate the numbers)

Fibonacci Channels
The Fibonacci pattern can be applied to channels not only vertically, but also diagonally, as shown in Figure 5.



Figure 5: Fibonacci retracement when used in combination with Fibonacci channels can give a trader extra confirmation that a certain price level will act as support or resistance.
Source: MetaTrader



Again, the same concepts that apply to vertical retracements apply to these channels. One common technique employed by traders is the combination of diagonal and vertical Fibonacci studies to find areas where both indicate significant resistance. This can be a sign of a continuation of the prevailing trend.

Putting It All Together
By combining indicators and chart patterns with the many Fibonacci tools available, you can increase your chances of a successful trade. Remember, there is no one indicator that predicts everything perfectly (if there were, we'd all be rich). However, when many indicators are pointing in the same direction, you can get a pretty good idea of where the price is going.
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