Using Fibonacci sequence to find support and resistance levels in trading

Why Are Traders Using Fibonacci Sequence?

The Fibonacci sequence has been applied in financial markets for decades, but why does it remain one of the most popular tools in technical analysis? Simply put, this method helps traders quickly identify potential reversal zones of asset prices.

All of this originates from a mathematical phenomenon: the golden ratio found in nature. 13th-century Italian mathematician Leonardo Pisano (nicknamed Fibonacci) introduced this ratio to the Western world, and later traders discovered that this ratio also applies to price movements in financial markets. That’s why Fibonacci ratios have become standard analysis tools in modern forex trading, commodity trading, and more.

The Secret Behind the Numbers: How the Fibonacci Sequence Works

The first step to understanding Fibonacci applications is to grasp the pattern of this number sequence.

The core rule of the Fibonacci sequence is simple: each number is the sum of the two preceding ones, extending infinitely:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765…

This seemingly simple sequence contains magical mathematical relationships. When you divide any number in the sequence by its previous number, the ratio gradually approaches 1.618—that’s the legendary golden ratio. For example:

• 1597 ÷ 987 ≈ 1.618
• 610 ÷ 377 ≈ 1.618

Conversely, if you divide a number by the following number, the result approaches 0.618 (the reciprocal of 1.618):

• 144 ÷ 233 ≈ 0.618
• 610 ÷ 987 ≈ 0.618

There’s also an interesting ratio: dividing a number by a number two places larger results in approximately 0.382:

• 55 ÷ 89 ≈ 0.382
• 377 ÷ 987 ≈ 0.382

These three ratios—1.618, 0.618, and 0.382—form the mathematical foundation of the entire Fibonacci trading system.

Practical Application: Using Fibonacci Retracement to Find Entry Points

After understanding the math behind it, how do traders turn these ratios into actual trading signals? The answer is Fibonacci Retracement.

Fibonacci retracement is a method to identify potential support and resistance levels of an asset’s price. Traders draw retracement lines between any two points—usually the high and low of a clear upward or downward trend.

Based on Fibonacci ratios, the main retracement levels include:

• 23.6% – Minor correction zone
• 38.2% – Moderate correction zone
• 50% – Central level
• 61.8% – Key support/resistance
• 78.6% – Deep correction zone

Let’s look at a real example. Suppose gold rises from $1681 to $1807.93, a gain of $126.93. Now, we calculate the Fibonacci retracement levels:

• 23.6% retracement = $1807.93 - ($126.93 × 0.236) = $1777.97
• 38.2% retracement = $1807.93 - ($126.93 × 0.382) = $1759.44
• 50% retracement = $1807.93 - ($126.93 × 0.5) = $1744.47
• 61.8% retracement = $1807.93 - ($126.93 × 0.618) = $1729.49
• 78.6% retracement = $1807.93 - ($126.93 × 0.786) = $1708.16

When gold prices decline, these levels become potential entry points for traders. If the price retraces to the 61.8% level, traders may see this as a support level and consider placing buy orders.

Trading Strategies in an Uptrend

In an upward market, traders typically encounter two scenarios:

Scenario 1: Finding retracement levels before a rebound

When an asset’s price surges and then begins to fall, traders need to identify three key points:

• Point A: the bottom (start of the uptrend)
• Point B: the top (end of the uptrend)
• Point C: the expected reversal point (a Fibonacci retracement level)

Within the A-B price range, the 23.6%, 38.2%, 50%, 61.8%, and 78.6% retracement levels can serve as support zones. When these levels are identified, traders can consider placing buy orders, waiting for a rebound.

Typically, the 61.8% Fibonacci retracement level is the most watched, as it often provides the strongest support.

Trading Strategies in a Downtrend

In a declining market, the logic is reversed:

• Point X: the high
• Point A: the low
• Point B: a Fibonacci retracement level

As the price falls from the high to the low and then begins to rebound, traders can place sell orders at these Fibonacci levels. These levels act as resistance, preventing further upward movement.

Going Further: Using Fibonacci Extensions to Set Target Prices

If Fibonacci retracement helps traders find entry points, Fibonacci extensions are used to determine when to exit.

Based on the same golden ratio, common extension levels include:

• 100% – equal to the initial upward move
• 161.8% – based on the 1.618 ratio
• 200% – double the initial move
• 261.8% – further extension
• 423.6% – deeper target

In an uptrend, traders identify three points:

• Point X: initial bottom
• Point A: initial top
• Point B: retracement support level (usually a Fibonacci retracement level)

From point B, the price may rise to various Fibonacci extension levels (100%, 161.8%, or higher). These levels become potential take-profit targets. When the price approaches point C (an extension level), traders can consider closing positions or taking partial profits.

Combining Techniques in Practice

Successful trading isn’t based on a single indicator. Traders often combine Fibonacci applications with other technical analysis tools:

• Trendlines to confirm support/resistance
• Moving averages to determine trend direction
• Candlestick patterns to confirm reversals
• Volume data to validate price action

This approach reduces false signals and increases the probability of success. For example, when the price hits the 61.8% Fibonacci retracement and a bullish candlestick pattern (like a hammer or engulfing pattern) appears, the buy signal becomes more reliable.

Why Is Fibonacci Application So Effective?

It may seem coincidental, but Fibonacci ratios are so effective in financial markets because:

1. Market Participant Consensus – Many traders use the same Fibonacci levels, creating a self-fulfilling prophecy.
2. Psychological Basis – Humans are naturally sensitive to the golden ratio, reflected in collective trader behavior.
3. Mathematical Universality – Fibonacci sequences are everywhere in nature, and this pattern appears to influence human economic behavior.
4. Statistical Validation – Long-term market data shows that prices tend to reverse more frequently near Fibonacci levels.

Tips for Beginners

If you’re just starting to use Fibonacci applications, keep these points in mind:

• Identify Trends Correctly – Use Fibonacci only within clear uptrends or downtrends; otherwise, signals can be confusing.
• Multiple Timeframes – Fibonacci levels on daily charts are generally more reliable than on minute charts.
• Prioritize Risk Management – Fibonacci levels are references, not guarantees; set reasonable stop-losses.
• Avoid Overtrading – Not every Fibonacci retracement level warrants a trade; wait for high-probability setups.
• Continuous Learning – Markets evolve, and different assets behave differently; adjust your application accordingly.

The power of Fibonacci sequence in trading lies in providing an objective, mathematically grounded framework for market analysis. However, tools alone don’t trade; ultimately, success depends on the trader’s experience, discipline, and risk management skills.