Fibonacci retracement is a method used by most traders to predict the direction an asset will move. In essence, this method utilizes a series of numbers that can help to determine when to enter or exit a market position. You can use this technique to trade just about any type of asset including currencies, indices, commodities and stocks.
What Are Fibonacci Retracements In Binary Options Trading?
The series of numbers used in this trading method is known as the Fibonacci sequence. The most popular retracements are 38.2% and 61.8%, which can be rounded off to the next whole numbers—38% and 62% respectively.
Traders who use chart patterns as part of their technical analysis apply these ratios to determine potential reversal levels on the movement of an asset. Additionally, Fibonacci retracements are also useful in forecasting how long a counter trend will last after the price of an asset falls.
How does the Fibonacci sequence look like?
Fibonacci retracements are derived from a precise sequence of numbers. Every new number is equal to the sum of the previous two numbers. For example: 1,1,2,3,5,8,13,21,34…etc.( 1+1=2, 2+3=5, 3+5=8….etc.) The sequence will go on and on to infinity.
When you divide a new number by the previous number, the answer is always approximately 1.618. For example, 21/13=1.615, 34/21= 1.6190, 89/55= 1.6181 etc. As the numbers increase, the approximation comes closer and closer to 1.618.
When you divide a number by the next highest number in the series, the answer is always approximately 0.6180. For example, 3/5=0.6, 8/13=0.615, 34/55= 0.618. As the numbers increase, the approximation comes closer and closer to 0.6180.
This sequence is how the 61.8% ratio or retracement is derived.
When a number is divided by another that is two levels higher, the answers is always approximately 0.3820. For example, 3/8=0.37, 5/13=0.3846, 8/21=0.3809, 13/34=0.382 etc. As the numbers increase, the approximation comes nearer to 0.382. This is how the 38.2% retracement is arrived at.
How the Fibonacci sequence works to alert on potential reversal
Traders use retracements to identify potential levels at which the movement of an asset may reverse. These levels are also known as resistance or support levels. In other words, each of the numbers in the sequence is a support or resistance level on the chart of the asset that you are trading.
Why are retracements inevitable in all financial markets? Simple: the nature of the market says that traders who jumped aboard a given asset early will look to stop and take some profits after a while, inducing a temporary reversal of the prominent trend.
So, when an asset moves in a certain direction, it will typically encounter some resistance at the 23.6% point. If the asset’s price is in decline, when it reaches this 23.6% mark, the decline will stabilize and maybe retrace. This resistance is only short-term such that the price will continue to decline in just a short while. The resistance will also typically be encountered at the 38.2% mark and then again at the 61.8% mark.
When it comes to applying Fibonacci retracements in binary options trading, the rule of the game is to always trade according to the prevailing trend and not against it. When you encounter a resistance, your best bet would be to wait it out until the trend stabilizes or proceeds on its course.
Retracements are best used together with other technical indicators and chart patterns to develop a solid trading strategy. When used correctly, Fibonacci retracements are a very powerful method of finding support/resistance levels in the markets.