SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Sign in to follow this  
Followers 0

Introduction to the Golden Ratio and Fibonacci Retracements


A mathematician who lived from 1170 to 1250 named Leonardo Pisano Bogollo introduced the Fibonacci sequence to the West, and tools based on that number sequence are still used by traders and other occupations today. What Leonardo found was a mathematical property that exists throughout nature and his sequence of numbers, called the Golden Ratio.

This ratio is found in sunflowers, the Pantheon spiral galaxies and other natural and manmade structures. Nature, and humans which are a part of nature, seem to gravitate toward the Golden Ratio in such ways as how we assess beauty and buy and sell to determine market prices.

 

One of the ways isolate the Golden Ratio, or fractions of it, in financial markets is through two tools available on most charting platforms called the Fibonacci Retracement and Fibonacci Extension tools. These isolate areas of potential support and resistance providing potential entry and exit points for traders willing to learn how to use these tools.

 

Fibonacci Sequence and the Golden Ratio

 

Leonardo came up with the following series of numbers, within which there are some interesting mathematical properties:

 

0,1,1,2,3,5,8,13,21,34,55,89,144,233,377...

  • Each number in the sequence is the sum of the two prior numbers (after 0 and 1)
  • If you divide a number (after the first few in the sequence) by the prior number, the result is very close to 1.618.
  • If you divide a number the next (higher) number, the result is very close to 0.6180.
  • If you divide a number two spots higher, the result is very close to 0.3820.
  • If you divide a number by three spots higher, the result is very close to 0.2360.

 

The Golden Ratio is 1.618, and the inverse of it is 0.618. Therefore, these levels along with 0.3820 and 0.2360 are used by traders to foretell areas of potential support and resistance as market movements seem to ascribe to similar relationships as in the sequence. The 0.50 level is also a common level used.

 

Usually these numbers are referred to as percentages in the follow way: a "61.8% retracement" or a "38.2% retracement."

 

Fibonacci Retracements

 

The mathematical properties above provide us with common retracement levels for market moves, namely 23.6%, 38.2%, 50%, and 61.8%. There are others, but these are the most common and generally the most useful.

 

A retracement is when the price of a trading product pulls back (retraces) a prior move. For example, if the price of a stock trends higher from $10 to $14, and then pulls back to $12, that would be a 50% retracement.

 

The stock moved up a total of $4 during the uptrend, but pulled back $2, or half of the prior gain.

 

Financial markets often retrace roughly 23%, 38%, 50% or 62% of a prior move (either up or down), and a simple tool available on most charting platforms lets you easily see these levels.

 

In the next down wave, the retracement following finds resistance at the 61.8 level.

 

While I have attempted to separate the Fibonacci Retracement drawings for easier reading, in practice it is fine to let them overlap. Having multiple drawings overlap each can actually be a valuable practise. When

 

Fibonacci levels from multiple drawings (even on different time frames) converge at a specific price, it is likely to be an important price and even a turning point.

 

Final Word

 

The Fibonacci Retracement is a simple tool that can be used to identify areas of potential support and resistance. Don't expect the market to stop exactly at a Fibonacci level. Often the price will come close to it, but not reverse exactly at it. The levels are a guide. Therefore, when trading off Fibonacci Retracements, don't make a trade anticipating a reversal at a certain level, but rather wait for the market to actually react off a Fibonacci level. For example, in a downtrend, if the price pulls back close to the 61.8 level and then begins to drop again, that is when you'd enter short (buy puts). Don't assume a Fibonacci level will hold, because there are multiple levels. Wait for the reaction off the level before taking action.

 

This article was contributed by Cory Mitchell CMT, who also writes for www.binaryoptions.net.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!
Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • SPX Options vs. SPY Options: Which Should I Trade?

    Trading options on the S&P 500 is a popular way to make money on the index. There are several ways traders use this index, but two of the most popular are to trade options on SPX or SPY. One key difference between the two is that SPX options are based on the index, while SPY options are based on an exchange-traded fund (ETF) that tracks the index.

    By Mark Wolfinger,

    • 0 comments
    • 448 views
  • Yes, We Are Playing Not to Lose!

    There are many trading quotes from different traders/investors, but this one is one of my favorites: “In trading/investing it's not about how much you make, but how much you don't lose" - Bernard Baruch. At SteadyOptions, this has been one of our major goals in the last 12 years.

    By Kim,

    • 0 comments
    • 897 views
  • The Impact of Implied Volatility (IV) on Popular Options Trades

    You’ll often read that a given option trade is either vega positive (meaning that IV rising will help it and IV falling will hurt it) or vega negative (meaning IV falling will help and IV rising will hurt).   However, in fact many popular options spreads can be either vega positive or vega negative depending where where the stock price is relative to the spread strikes.  

    By Yowster,

    • 0 comments
    • 799 views
  • Please Follow Me Inside The Insiders

    The greatest joy in investing in options is when you are right on direction. It’s really hard to beat any return that is based on a correct options bet on the direction of a stock, which is why we spend much of our time poring over charts, historical analysis, Elliot waves, RSI and what not.

    By TrustyJules,

    • 0 comments
    • 478 views
  • Trading Earnings With Ratio Spread

    A 1x2 ratio spread with call options is created by selling one lower-strike call and buying two higher-strike calls. This strategy can be established for either a net credit or for a net debit, depending on the time to expiration, the percentage distance between the strike prices and the level of volatility.

    By TrustyJules,

    • 0 comments
    • 1,490 views
  • SteadyOptions 2023 - Year In Review

    2023 marks our 12th year as a public trading service. We closed 192 winners out of 282 trades (68.1% winning ratio). Our model portfolio produced 112.2% compounded gain on the whole account based on 10% allocation per trade. We had only one losing month and one essentially breakeven in 2023. 

    By Kim,

    • 0 comments
    • 5,900 views
  • Call And Put Backspreads Options Strategies

    A backspread is very bullish or very bearish strategy used to trade direction; ie a trader is betting that a stock will move quickly in one direction. Call Backspreads are used for trading up moves; put backspreads for down moves.

    By Chris Young,

    • 0 comments
    • 9,496 views
  • Long Put Option Strategy

    A long put option strategy is the purchase of a put option in the expectation of the underlying stock falling. It is Delta negative, Vega positive and Theta negative strategy. A long put is a single-leg, risk-defined, bearish options strategy. Buying a put option is a levered alternative to selling shares of stock short.

    By Chris Young,

    • 0 comments
    • 11,146 views
  • Long Call Option Strategy

    A long call option strategy is the purchase of a call option in the expectation of the underlying stock rising. It is Delta positive, Vega positive and Theta negative strategy. A long call is a single-leg, risk-defined, bullish options strategy. Buying a call option is a levered alternative to buying shares of stock.

    By Chris Young,

    • 0 comments
    • 11,527 views
  • What Is Delta Hedging?

    Delta hedging is an investing strategy that combines the purchase or sale of an option as well as an offsetting transaction in the underlying asset to reduce the risk of a directional move in the price of the option. When a position is delta-neutral, it will not rise or fall in value when the value of the underlying asset stays within certain bounds. 

    By Kim,

    • 0 comments
    • 9,671 views

  Report Article
Sign in to follow this  
Followers 0


We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs