What are Fibonacci correction levels?

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Leonardo Fibonacci
Leonardo Fibonacci

It’s actually quite simple – Fibonacci correction levels are levels of support and resistance; these levels are potential areas of interest during a price movement. Think of it as a sort of “ceiling” and “floor” of a price movement.  It differs from the usual support and resistance because Fibonacci correction levels are calculated on the basis of the Fibonacci sequence and are based on the principle of the “Golden Ratio”.

Why are Fibonacci correction levels called “correction levels”?

In order for us to form the support and resistance using Fibonacci calculation we need to have a corrective price movement, a price increase after a fall and/or likewise a price drop after its rise. With the help of Fibonacci correction levels, we can determine further targets for growth or fall in price.

If the price rises and does not go down, or falls and does not go up – it means that, unfortunately, it is not possible to build Fibonacci correction levels yet. We have to wait for the correction.

How are Fibonacci correction levels calculated?

Imagine that the price of an asset rose from $100 to $200. In our case this will be the main trend. Now, the price is starting to decline. The upward movement of $100 is regarded as 100%. This segment is then divided according to the “golden ration”. For what purpose? Because, these divided segments provide an excellent opportunity to determine support and resistance levels.

How can we quickly divide these segments according to the “golden ration”? Its very simple, just multiply the values by the corresponding Fibonacci coefficients – 0.236; 0.382; 0.618; 0.786 (please refer to our previous course to learn about the Fibonacci sequence). In this way, we obtain 4 levels (100*0.236 = 23.6; 100*0.382 = 38.2; 100*0.618 = 61.8; 100*0.786 = 78.6). It is these values or levels that can be used to determine price corrections.

So, the first level of support will be 200-23.6 = 176.4 (price), or 23.6% Fibonacci level of correction; the second level is 200-38.2 = 161.8, or 38.2% Fibo correction; the third level is 200 – 61.8 = 138.2, or 61.8% Fibo; and the fourth level is 200 – 78.6 = 121.4, which is the 78.6% Fibonacci correction. In addition to these four levels, there is another important level to consider, the 50% level of the total correction, which is the $150 mark.

Why is the 50% correction level so important? The most important rule of trading

One of the most important rules of trading is the following: markets tend to retrace, meaning the price tends to return by a fraction of a third or half of the length of the previous trend, before resuming further movement.  This is why 50% Fibo correction is the most important level that the price tests.

The most important levels of correction, aside from 50%

The most important Fibonacci levels of correction are 38.2% and 61.8%. It is at these levels that we may most often expect that the price will stop or even possibly reverse.

Using the “Fibonacci Levels of Correction”

Actually, it is not necessary to make constant calculations for Fibonacci correction levels as we showed you earlier. Now days, majority of trading platforms that provide access to real-time asset quotes have the “Fibonacci levels of correction” or “Fib retracement” instrument available within the platform. All that’s left to do, is to determine the main trend and correction in relation to it. Here is where many traders get confused, how to choose the first (starting) point…?

Let’s take a closer look. Often, when a price is moving up or down for a prolonged period of time, the price forms peaks (maximums or highs) and drops (minimums or lows) which can be considered as first (starting) points.

There is no strict rule here. For example, let’s consider different time frames.

Examples:

  • On a TF (time frame) of 1H (1 hour) our chart displays the price change and movement for the previous 2 weeks
  • On a 4H TF the chart is displayed for the previous 6 months
  • A Daily TF gives us an opportunity to see the chart for the past 2 years
  • Weekly TF – 6 years
  • Monthly TF – 13 years

Now, it is considered that a correction can last only up to the Fibonacci correction level of 61.8%. If the price intersects this level, it is now necessary to rearrange the Fibonacci correction levels.

What to do after selecting the first (starting) point?

Once we select our TF and period of time which we are analyzing, we need to find the starting point. It’s quite simple – the starting point is either the maximum price (peak) or minimum price (low) on the chart for the selected time period. If we are building our correction levels on a downward (Bearish) trend, our starting point will the be the minimum. If we are looking for our starting point on an upwards (Bullish) trend our starting point will be the maximum price value that is displayed on the chart. The starting point is the first point of the Fibonacci correction levels, from which we then stretch the grid with levels onto the chart so that the last level touches the opposite price value (maximum or minimum), which is the value from which the correction began.

Fibonacci levels

Which Time Frame is best suitable for Fibonacci correction levels?

Any TF. Fibonacci correction levels will work on any time frame that you choose. However, it should be noted that most technical analysts do not recommend going below the 1H TF, because the price becomes more susceptible to the so called “market noise” and random movement that can not be predicted.

What to do after building the Fibonacci correction levels?

Now you have an excellent tool to predict further price movement targets. To get more in-depth information on how to properly choose and build the Fibonacci correction levels we recommend for you to watch our webinars and master class videos.

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