The markets are constantly moving in different directions. As a trader your making money when you are able to identify high probability zones where price will continue to move or reverse in the direction you anticipate. To assist in your accuracy you use various tools.

These tools may include moving averages, volume, overbought and oversold indicators and the like. For a select few, at the very top of the list of indicators is the Fibonacci tool-set. Not a replacement for anything you currently use, but a fantastic confidence builder when looking for low-risk entry.

I want to cover in this article how to use Fibonacci extensions and retracements. These are the most popular of the Fibonacci tools for use in trading stocks, options or forex. If you want more accuracy and precision these tools are absolutely critical.

Fibonacci retracements refer to a corrective wave, and extension refer to an impulse wave. Meaning with the Fibonacci retracement tool we are measuring where price will retrace to before resuming the previous trend, and with extensions we are measuring where price will make a new high or low beyond its most recent high or low.

Fibonacci retracements are retracing old territory. Let’s talk about Fibonacci retracements related to a bull market. Its simply the opposite for a bear market. Now when measuring a retracement what were looking for is where price will fall to before resuming the trend.

Keep in mind that the previous high = 100% of the move between the previous low and that high. So now we begin to measure the “corrective wave” and how much it will correct. Here are the most common and most accurate retracement levels:

* 23.6% – This level is first and represents the least amount of penetration into the impulse wave. It usually means BIG MOVE coming. * 38.2% – This is a nice level, it’s still shallow but represents a decent retrace and points to a BIG MOVE as well. * 50% – 50% is what we tend to anticipate when eyeballing a retracement. I would say that my biggest money-makers fall right between 50% and 61.8. * 61.8% – Generally anything beyond this and I’m out. In fact like I said previous, I’m a big fan of right smack between 50% and 61.8%. * 100% – If we hit 100% then it’s not likely we should be looking to get into the next impulse wave because it’s likely over. Time to re-think your stance.

Once we measure the low and the high a typical Fibonacci retracement tool will lay out the retracement levels starting with 23.6 and ending at 100%. This makes it easy to see the levels and wait and see what price does at these levels.

When price finds support at one of the retracement levels, and depending upon which level the next step is where do we exit? If price makes it beyond the original 100%, this is where we implement extensions.

You’ll notice when you lay down your retracements, extensions will automatically be laid out for you. So when price hits the 38.2% retracement level and reverses once it reaches the high its at 100% – Beyond that are extensions. The two most common extension levels are 161.8 and 261.8 %

So you see, what many people mistakenly take as a mere mathematical abstraction, just “fooling around” with numbers, is rooted in very real-world applied mathematics. To state things very basically, the Fibonacci sequence can be used to detect and describe otherwise hidden patterns in the world around us.

It works really well while investing. Why? Well, based on the mass behavior of investors there are various hidden patterns in the stock market. Perceptive investors know this. Investment aphorisms such as “The best time to buy is when there’s blood in the streets” and “Buy low and sell high” work well. However, they also relate to understanding the investment markets hidden patterns.

These patterns cannot be seen by a day to day observation of market conditions, but reveal themselves when you step back and take a look at the big picture. Short term fluctuations in the market are nearly impossible to accurately forecast. However, the trends which occur over time most certainly are predictable. Investors of all stripes, including Forex traders have used the Fibonacci sequence to plan their investments and make large profits in the currency exchange markets.

The Fibonacci sequence is a string of numbers with each number being the sum of the two numbers which preceded it. For example, one such string would be 1,1,2,3,5,8,13,21 and so on. These numbers are related in several ways. Any given number in a Fibonacci sequence is about 1.618 of its predecessor – the “golden ratio” of the Greek mathematicians.

Of all the Fibonacci series the two applications in wide spread use by Forex traders and investors are arcs and retracements.

Fibonacci chart technique involves three curved lines drawn for anticipating key resistance and supporting various levels as well as areas of ranging. First drawn is an invisible trendline between the two points of high and low for particular period of time. Next, three intersecting curves are drawn overlapping the trendline at the levels of 38.2, 50, and 61.8 percent according to Fibonacci. When the price of the asset crosses through these key levels, decisions of transaction are made.

Now, a retracement, in investing, refers to a reversal in the movement of a stock’s price–a reversal which is enough to counter the stock’s prevailing trend. Advanced successful investors pay intense attention to retracement possibilities and patterns. The Fibonacci retracement analyzes the likelihood that a financial asset’s price will see a larger than average retracement and then come to support or resistance at the key Fibonacci levels before it then continues on in its original direction. A trendline is drawn between two extreme points; then, its vertical distance is divided by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%.

Multitudes of high-level traders gain with the Fibonacci retracement method. It aids them in finding the most strategic placement of transactions, their target prices and stop-losses. Gartley patterns, Tirone levels and the Elliott Wave theory are other technical tools that make use of retracement.

The Fibonacci formula simply works and is useful while investing. Forex traders worldwide are finding it successful while using it.