Retracement levels are a popular tool used by traders to identify turning points in cryptocurrency prices. Without proper knowledge, traders might enter into crypto trades without confidence, which can lead to unnecessary losses.
While the Fibonacci Retracement tool is commonly used in the traditional stock or forex market, you’ll be surprised to know that it works wonderfully for cryptocurrency markets too. In this guide, we’ll educate on the retracement meaning in cryptocurrency trading and how you can use a tool like the Fibonacci Retracement so that you can learn to utilize it to find critical levels on a trading chart.
Retracement Meaning
A retracement is a level on a stock or cryptocurrency’s price chart at which its price tends to see a reversal in its trend. Distinct from a reversal, retracements are short-term periods of movement against a trend, followed by a return to the previous trend.
A retracement by itself does not say much, but when combined with other technical indicators such as the Fibonacci Retracement tool, it can help a trader identify if the current trend is likely to continue or if a significant reversal is taking hold.
What Are Fibonacci Retracement Levels?
Fibonacci retracement levels that stem from the Fibonacci sequence, are horizontal lines that indicate where support and resistance are likely to occur. Each level is associated with a percentage. The percentage is how much of a prior move the price has retraced.
These levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used. The indicator is useful because it can be drawn between any two significant price points, such as a high and a low. The indicator will then create the levels between those two points. Suppose the price of a cryptocurrency rises $10 and then drops $2.36. In that case, it has retraced 23.6%, which is a Fibonacci number.
What Does A Fibonacci Retracement Do?
Markets don’t go straight up or down – there are pauses and corrections along the way. In looking to buy stocks or cryptocurrencies in an uptrend, one would look to get the best price possible. As such, some traders use Fibonacci Retracement to determine how much a stock could pull back before continuing higher. Traders can use these retracement levels to find optimal prices at which to enter a trade.
How And Why Does Fibonacci Retracement Work?
There are several theories as to why the Fibonacci Retracement works. Some of these include:
- Fibonacci price levels reflect the effects of extreme fear and greed in the market. To use this to their advantage, traders might buy when people are fearful and sell when others are getting greedy.
- Fibonacci patterns are often observed in nature as well as in mathematics. For example, in fruits and vegetables. If one would look at the center of a sunflower, spiral patterns could appear to curve left and right. Counting these spirals, the sum is often a Fibonacci number. If one could divide the spirals into those pointed left and right, then two consecutive Fibonacci numbers could be obtained.
- The law of numbers: If a greater percentage of people practice Fibonacci crypto trading, then the likelihood of its accuracy increases.
- At its core, a Fibonacci retracement is a mathematical measurement of a particular pattern. When it comes to Fibonacci in crypto, traders try to apply these patterns to price action to predict future price movements.
Limitations Of Fibonacci Retracement
- Fibonacci retracements in crypto or other markets may be slightly predictive. But over relying on them can be counterproductive for reasons such as:
- Fibonacci retracements, like any other indicators, could be used effectively only if investors understand it completely. It could end up being risky if not -used properly.
- There are no guarantees that prices will end up at that point, and retrace as the theory indicates.
- Fibonacci retracement sequences are often close to each other, therefore it may be tough to accurately predict future price movements.
- Using technical analysis tools like Fibonacci retracements can give investors tunnel vision, where they only see price action through this one indicator. Assuming that any single indicator is always correct can be problematic.
- A Fibonacci retracement in crypto trading could oftentimes wind up being even less predictive than in other financial markets due to the extreme volatility that cryptocurrencies often experience.
Using The Fibonacci Retracement Tool to Trade Cryptocurrencies
In order to get started with a Fibonacci Retracement Tool, a trader could find a completed trend for a crypto, say, Bitcoin, which could either be an uptrend or downtrend. Below are some steps on how to use Fibonacci retracement tool:
1. Determine the direction of the market. Is it an uptrend or downtrend?
2. For an uptrend, determine the two most extreme points (bottom and top) on the Bitcoin price chart. Attach the Fibonacci retracement tool on the bottom and drag it to the right, all the way to the top.
3. For a downtrend, the extreme points are top and bottom and the retracement tool could be dragged from the top to the bottom.
4. For an uptrend or downtrend, one could monitor the potential support levels: 0.236, 0.382, 0.5 and 0.618.
Closing Thoughts
Now that you know the retracement meaning and how the Fibonacci Retracement tool can help identify not-so-obvious levels of support and resistance, you can now better time trades and possibly attain a higher winning percentage.
Though, the Fibonacci tool is believed to be more effective when utilized with higher market capitalization cryptocurrencies, like Bitcoin and ETHereum. The reason for that is because they have more established trends over extended time frames as compared to cryptocurrencies with a smaller market capitalization.
