Fibs are the poster child of classic technical analysis: Draws colourful lines on chart based on a string of numbers selected through an idea nobody understands. Fibs are a technical tool that everyone uses because everyone uses it.
Fibs are the black-box tool that everyone uses because everyone uses it. Don’t shun them because of that though.
In case you are a Fibs-virgin, let’s define what we’re talking about.
Fibs, or Fibonacci levels, are a tool that estimates future support or resistance levels. These estimates are based on some pretty opaque theory.
On a chart, Fibs look like this:
How to draw Fibs
Fibs are used when the market corrects or bounces. Those are short term movements that follow a more substantial run. The correction or bounce are not usually a start of a new trend, just a cool-off.
Fibonacci lines are useful during market retracements.
There is a good use case for Fibs together with Wyckoff for trading ranging markets.
- In a correction (price decline after a run) you draw Fibs by clicking on the swing high and dragging to the swing low.
- The Fib retracement will expand upwards. The levels it shows are future resistance levels.
- In a bounce (price increase after a slump) you draw Fibs by dragging from the swing low to the swing high.
- The Fib retracement will expand downwards. That gives you the estimated support levels.
Fibs are constructed the same way at every market: It will always be, say, 1.618 no matter if the Fib is plotted on oil futures chart or on ETHUSD.
It would be easy to dismiss Fibs as an irrational tool that deserves to disappear from history.
On markets trending above previous ATH there is no price history to work out support and resistance from. It just so happens that traders like to use Fib lines to estimate future support and resistance levels. As long as everyone uses Fibonacci lines, they will work because people will set their orders around them.
MrJozza in the following short video explains the concept of trading on Fibs with examples on BTCUSD:
Why does everyone in crypto use Fibs?
Fibonacci retracements are the bread and butter of cryptocurrency trading.
If you only came to crypto after 2017, maybe you don’t think so. But watch the Fib charters pop up once a big cryptocurrency pair makes it past its ATH.
And that’s exactly the reason why Fibs gained so much popularity on crypto markets.
- When a market is new, like cryptos were even quite recently, there is no price history.
- Without price history, most technical analysis tools go to pieces, because they need some input data to make statistics from.
- With no price history, you can’t even draw suppport and resistance lines…
- …Just like you can’t draw support and resistance on a market that’s past the ATH.
A Tool that facilitates agreement
Fibs could be based on a completely random sequence of numbers for all we know. It makes no difference. As long as traders will want to set up their take-profit orders, Fibs will always work.
That doesn’t mean that Fibs don’t leave room for the actual free market, though.
They are simply an easy to use tool that marks the price zones where crypto traders start taking profits.
For every retracement, you are always gives multiple Fib levels: 0.618, 1.618, 2.618, 4.236.
The market sentiment will show itself in the level of the Fib line that will eventually end up being the reversal.
- Is it lower high?
- Is it higher high?
- Is it way higher high?
The Fibs are just a suggestion pulled out of a mathematician’s a$$; for an extreme scenario the market can easily disregard all of them and just blast through.
I hope you now see it would be a gross oversimplification to call even random black box tools like Fibs simply a self-fulfilling prophecy.
Flocking to an indicator is more common than you think
In April 2018, John Bollinger asked on Twitter what everyone’s favorite technical indicators are.
Given that many people aspire to be like John Bollinger, we got this whole “notice me senpai” effect. It is safe to assume people told the truth.
The low variety of the results is not very surprising.
Traders generally flock to the same indicator. And they rarely use a truly unique set up.
Unless you live under a rock you’ll be well aware that when it comes to crypto trading, pretty much the same chart setup gets plastered all over cryptotwitter and cryptoreddit.
That is precisely the reason why Fibs work.
But be careful: It is also the reason why stop hunts happen.