You may wonder what is the purpose of this and how it is possible to have more than one way to draw a Fibonacci retracement, for example. Well, you’ll be surprised. It depends very much on the type of your analysis, on what you are actually looking for. If you are counting the waves using the Elliott wave theory, than Fibonacci retracement should be used in one specific way, and this is the standard interpretation of it. But for other purposes, the habit of drawing a Fibonacci retracement from top to bottom and looking at the resulting proportions is not working and it is considered totally wrong. And this is the modern view about the famous ratio.
Using the Elliott waves theory trying to count the waves and not having Fibonacci retracements to help it is impossible because the whole theory it is based on retracements, relationships between the waves, proportions within the legs of a specific pattern (contracting and expanding triangles, 2nd and 4th waves retracements, etc). For example, when you are looking for a 4th eave type retracement first thing you need to know is that such a wave must retrace minimum 20% of the previous 3rd wave length. So what you should do is to take a Fibonacci retracement tool, measure the previous 3rd wave from top to bottom and look for the minimum retracement level to be touched. Then you should be aware 4th waves types usually retrace around 38.2% out of the previous 3rd wave length, and rarely go above 50% retracement. So based on your Fibonacci retracement applied on the 3rd wave from top to bottom you can actually identify this levels and look for a reaction once price comes close. But this is only one way to use the Fibonacci retracement, and while it is correct when applied together with the Elliott Waves Theory, it is not sufficient when used alone.
According to the modern interpretation of the Fibonacci retracement tool, if you want, from example, to find the resistance price level over the current market price you must start with a price low and move your cursor toward a price high, and the resulting subdivisions of the range must be above the current market price. The opposite is valid if you want to find support, you start from a price high toward a price low. The explanation for such an approach is that if not doing so, you will never be able to consider the internal proportions forming withing the range of a price swing. Under this approach, a valuable information is to look for confluence areas between different ratios applied on different subdivisions of the same swing.
Another interpretation of the new approach to Fibonacci is to draw the ratio not from the actual top or bottom, but trying to measure the internal of the swing. In this way spikes are being eliminated and the range is more valuable in finding confluence zones. W.D. Gann stated that he often found secondary swing away from the actual bottom to be of greater value than the actual price that ends the prior trend. And that means trying to avoid highs and lows when drawing a Fibonacci retracemnt. Under the same approach it is believed that the only time a trader will have success by using a Fibonacci ratio derived by taking the extreme market high and low is when all the 50% lines fall on top of one another.
For the purpose of our project here this chapter will have three recordings, the first one showing you the traditional way of using a Fibonacci retracement tool, under the Elliott Waves Theory, the second one showing you how to look for support and resistance area after drawing the Fib as described in here, and the third one will deal with confluences and showing you Fibs not taking from the actual highs and lows do have sense in trading.
Constance Brown, Fibonacci Analysis, 2008, Bloomberg Press – The Concept of Market Expansion and Contraction