How to Use Fibonacci on Charts
The Fibonacci sequence has become synonymous with technical analysis on stock charts. In 1202, Leonardo Pisano published his book "Liber Abaci," which explained how to use the Fibonacci sequence to predict future growth numbers; little could he know that, centuries later, it would still be applicable and used worldwide as a technical analysis tool. This simple mathematical sequence is used by stock traders as a stock-prediction tool of good entry and exit points. Most popular are the Fibonacci retracement ratios and the Fibonacci extension ratios.
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Instructions
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Use Fibonacci retracement ratios to predict stock entry points. Looking at a chart for a stock, identify a recent swing trade high and swing trade low range. Calculate the range by subtracting the low price from the high price; then multiply it by a Fibonacci ratio. According to website swing-trade-stocks.com, the most popular Fibonacci retracement ratios used for entry points are 23.6 percent, 38.2 percent, 50 percent and 61.8 percent. Take the resulting number and subtract it from the swing trade high. Draw lines on the chart to represent these prices; these signal points that a stock will often hit before retracing back to previous highs. Traders often enter a stock on the way down, as it hits one of these ratios, in hopes of realizing a profit if the stock retraces.
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Predict stock exit points using Fibonacci extensions. When a stock retraces more than 100 percent, use a Fibonacci extension ratio to predict its future run, which would signal a good exit point. According to swing-trade-stocks.com, the most common Fibonacci extension ratios used are 1.618 and 1.272. Take the difference from the swing high to the swing low and multiply it by one of the Fibonacci ratios. Add this number to the price of the stock at the bottom of the swing. The resulting number is a good indicator of where the stock will head.
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Place trailing stops using Fibonacci extensions. After a stock has hit a bottom and commences to retrace, begin to place trailing stops as it passes through the same Fibonacci ratios -- 23.6 percent, 38.2 percent, 50 percent and 61.8 percent -- to lock in profits.
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Keep a running chart of both retracement and extensions so you can visualize Fibonacci clusters. As the trades progress through time, keep your Fibonacci lines current on your stock chart. You will begin to see trade range patterns, or Fibonacci clusters, that indicate good entry and exit points for short-term trading.
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Tips & Warnings
Most trading platforms have Fibonacci grids as a functional tool for your stock chart, so you do not have to figure the equations or ratios manually.
Technical analysis is an art form and is not 100 percent accurate. Its patterns and tools are based on high probability, not exact science. Keeping this in mind, remember that some profit is better than no profit.
