When looking at price patterns to determine your market strategy, some people tend to look at harmonic price patterns to predict the future market movement. The harmonic price patterns use Fibonacci numbers to determine pivot points within the market.
What is Fibonacci?
Fibonacci ratios were discovered by famous Italian mathematician, Leonardo Fibonacci, some time in the 13th century. Fibonacci saw that there were ratios which explained the natural proportions of things in and around the universe. While there is no set mathematical formula, it is the number sequence that has relevance here. He discovered that any given number was approximately 1.618 times the preceding number, but on a line, each number is also 0.618 of the number to the right of it. To simplify, let’s explain this in whole numbers.
Beginning with 0 and 1, we add the first number in the series to the second number to get the third number. You will see ratios emerge from the following series of numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
0 + 1 = 1
1 + 1 = 2
1 + 2 = 3
2 + 3 = 5 and so on…
The Golden Ratio
To get The Golden Ratio, divide the larger of the two consecutive numbers by the smaller number. Example, 55/34 = 0.618, or its inverse 34/55 = 0.618.
There are different uses of Fibonacci series when applied to time series charts for events like cryptocurrency market trends. To keep things simple, we will stay with Fib-Retracement and Fib-Extension and later deploy these concepts when we explain how it affects Harmonic patterns.
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Fibonacci Retracement Levels
Now, let’s look at a Fibonacci retracement level. Remember, the Golden Ratio is determined by using consecutive numbers on the line, but retracement is found by dividing alternating numbers, for example, 34/89 = 0.382 or 38.2% level.
Ratios/Percentages
0.236 (23.6%), 0.382 (38.2%), 0.500 (50%), 0.618 (61.8%), 0.786 (78.6%)…
Fibonacci retracements require a high and low price point. Select two points for the Fibonacci numbers and calculate the percentage of the market movement.
Traders who watch Fibonacci retracements will see large and small waves of movement. They can see market pullback with larger impulse waves moving the market in one direction or another with smaller wave fluctuations in between. As ratios move between 23.6% and 78.6%, traders may make a buy or sell decisions based on the larger trending direction.
Fibonacci Extension Levels
Many brokers and exchange platforms have developed their own proprietary tools using Fibonacci ratios to calculate levels automatically, but knowledge is power and understanding the mathematical theory is critical to making smart, informed decisions when it comes to investing and expanding your crypto portfolio.
A quick explanation of Fibonacci extension is that it requires three price points as opposed to the two which is used for the Golden Ratio or determining retracement.
These three numbers indicate the start of a move, the end of a move, and then any point in between, which indicates the pullback.
If you wanted to know the extension, let’s walk through a simple example.
The high and low are $30 and $40. Now let’s say we want to find the 161.8%, or 1.618 level above the chosen pullback number. If $38 is the third number used for this example, then we calculate $38 + (1.618 x $10) = $54.18 as the extension level.
These levels are used by traders to detect potential support and resistance areas in the cryptocurrency market, so knowing where the support and resistance levels are will help determine how traders place instant orders, or plan for long or short orders.
Harmonic Patterns
Harmonic Patterns was established by H.M. Gartley, who wrote about a 5-point pattern (known as Gartley) in his book Profits in the Stock Market. Though later improved by Larry Pesavento by using Fibonacci ratios to establish patterns, Scott Carney is credited with additional pattern theories like “Crab,” “Bat,” “Shark” and “5-0”, which helped create standard trading rules.
Harmonic patterns use Fibonacci ratio relationships and spots symmetrical patterns in the markets. Projections and retracements using the high and low swing points determine key price levels for Targets or Stops, or even entry point predictions for traders. Because the harmonic patterns are created by mathematical sequence and not emotional decisions, one merely needs to do a little bit of calculation, with given information to make well-informed predictions.
It’s important to note that while Fibonacci patterns are found throughout nature, the human element will always make market predictions a game of chance.
Trading with ABCD, Crab, Bat, Shark, or other patterns requires a bit of patience for the models to form based on the numbers you enter, but it’s wise to discover those emerging patterns before initiating a long or short trade. We will share another article that further explores these harmonic price patterns.
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