It is used to help traders get in at a good price by identifying strategic places for transactions, stop losses or target prices
The Fibonacci Projection is a popular tool among technical traders and is based on the key Fibonacci number series.
The basic idea behind Fibonacci Projection is that markets will retrace a predictable portion of a move, after which they will continue to move in the original direction and will extend above the earlier swing high.
It is also used for determining support and resistance levels. Fibonacci Projections are ratios used to identify potential reversal levels and the most popular Fibonacci Projections are 161.8 percent and 261.8 percent.
It is used to help traders get in at a good price by identifying strategic places for transactions, stop losses or target prices. However, it is most effective for confirming signals or conditions identified by additional technical analysis tools.
Construction & working of Fibonacci Projection
Understanding the underlying formula used for the construction of Fibonacci Projection levels can help traders in taking a prudent decision while trading in complex scenarios. Fibonacci numbers are a sequence of numbers in which each successive number is the sum of the two previous numbers.Fibonacci Ratios
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, and so on.
The Fibonacci sequence starts from 0 1 and every number thereafter is built by the sum of the previous two. Every number in the Fibonacci sequence is 61.8 percent of the next number.
As with other Fibonacci studies, the key Fibonacci Projection levels are found by performing mathematical operations on the numbers in the Fibonacci summation series, and on the results of those operations. The same levels used in Fibonacci price extensions are used in Fibonacci Projections.The application of Fibonacci projections differs from other studies as two price waves are required i.e. the initial wave and a completed wave in the counter direction. The Fibonacci price projection is then projected from the end of the counter-trend move.
Figure 1. Calculations of Fibonacci Projection Points
To draw Fibonacci Projections we need to understand the main trend of the market. We will be using three price points to draw Fibonacci Projections.For example, if the main trend is up and we have identified a swing low (A as shown in the picture below) and high (B as shown in pic below) of the uptrend and followed by a small correction(B-C below) of the above move (A-B). Most probably the length of the next upswing wave will be at a Fibonacci ratio.
Figure 2. Construction of Fibonacci Projection Ratios
In the first picture above, during an uptrend, we have seen an up move from A to B then a correction towards C. Probable termination point of next up move can be drawn using Fibonacci ratios: 38.2 percent, 50 percent, 61.8 percent, 100 percent, 138.2 percent, 161.8 percent, 261.8 percent etc. from the starting point ‘C’. percent.
> The Fibonacci Projection is available on most trading platforms, such as Tradingview and MetaTrader. The Fibonacci Projection tool is also available on many free online charting sites, such as Investing.com, StockCharts.com and Yahoo! Finance.
> Fibonacci Projection levels are most frequently used to provide potential areas of interest.
> Unlike moving averages, Fibonacci Projection levels are static prices. They do not change. This allows quick and simple identification and allows traders and investors to react when price levels are tested. Because these levels are inflection points, traders expect some type of price action, either a break or a rejection.
> The projection concept is also used in many indicators such as Tirone levels, Gartley patterns, Elliot Wave theory and more.
> Like all technical indicators, it is important to use the Fibonacci Projection in conjunction with other technical analysis tools.
Trading TechniqueThe Fibonacci Projection tool plots percentage retracement lines based upon the mathematical relationship within the Fibonacci sequence series. These ratios can be combined with other indicators and price patterns to create an overall strategy. One can use Fibonacci projection for profit booking purpose majorly.
Figure 3. Fibonacci Projection & Targets
(The author is Head - Technical & Derivative Research at Narnolia Financial Advisors Ltd.)Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.Subscribe to Moneycontrol Pro and gain access to curated markets data, trading recommendations, equity analysis, investment ideas, insights from market gurus and much more. Get Moneycontrol PRO for 1 year at price of 3 months at 289. Use code FREEDOM.