Fibonacci Levels and Harmonic Patterns

With extensive experience as an electrical/software/coding engineer along with having a diverse financial background, Thomas Wettermann’s areas of interests include Machine Learning (ML), artificial intelligence (AI), and Financial Technology (FinTech). For the past few years, Thomas Wettermann has focused on the underlying technologies that support and promote all phases of cryptocurrency ecosystems. 

Traders use harmonic patterns as a form of technical analysis to identify specific types of price chart patterns. These patterns are used to predict future price movements of an underlying asset. Harmonic patterns can be applied to all types of assets, including cryptocurrencies.

What Are Harmonic Patterns? 

Harmonic patterns represent specific formations that arise frequently in price charts. They help traders understand price action and predict the direction of the price. In addition, these patterns are used to identify trend reversal patterns so that traders can initiate a trade with a high probability of success. 

Harmonic patterns represent various price action points of an asset, like a stock. These patterns are highly structured and rely upon the application of Fibonacci ratios. By identifying patterns of varying lengths and magnitudes, Fibonacci ratios can be applied to predict future movements of the asset. 

Harmonic patterns illustrate a progression of up and down legs or price movements. Most common harmonic patterns include a progression of four legs or four pricing movements. These legs or pricing movements are defined by 5 price points in time. The lengths of these legs follow strict mathematical ratios. These mathematical ratios are represented by Fibonacci levels and represent the main retracement levels used for harmonic patterns. 

The pricing movements of different harmonic patterns can have different Fibonacci ratios. Fibonacci retracements and extensions are used to identify potential reversal zones: where there is a high probability that the price will reverse.

What Are Fibonacci Levels? 

Harmonic patterns rely on the Fibonacci numerical sequence and ratios that are derived from this sequence. The sequence starts with 0 and 1 and is generated by adding two previous numbers in the sequence to arrive at the next number. 

For example, the sequence begins with 0+1=1, 1+1=2, 1+2=3. Repeatedly applying this algorithm results in the following: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987 . . . 

Various Fibonacci ratios can be derived from this sequence. What is amazing about this sequence of numbers is how these Fibonacci ratios are present in many things in our daily lives and things throughout the universe, from their application to the human body, to galaxy formations, to architecture, and to DNA structures.

These ratios play a significant role in the financial markets, especially in the area of technical analysis. For example, these ratios are studied to provide clues as to where a given financial market will move. 

Certain key Fibonacci ratios include 61.8%, 38.2%, and 23.5%: 

• The 61.8% ratio is found by dividing one number in the sequence by the number that follows it. For example, 21 divided by 34 equals 0.6176, and 55 divided by 89 equals 0.61797. 

• The 38.2% ratio is derived by dividing a number in the sequence by the number located two positions to the right of that number. For instance, 89 divided by 233 equals approximately 0.38197. 

• The 23.6% ratio is found by dividing a number in the sequence by the number that is three positions to the right of that number. For example, 21 divided by 89 equals about 0.23595. 

Higher-order Fibonacci ratios include 1.272, 1.618, and 2.24. 

Traders use these ratios to predict price actions by applying Fibonacci retracements and extensions to pricing patterns that meet predefined criteria. 

 

(Source: Harmonic Patterns, Suri Dudella) 

As illustrated in the figure on the left, a price pattern is represented by an initial swing or leg designated at XA. 

From this swing XA, a retracement — leg AB — represents a minor pullback or change in the direction of the swing XA. Fibonacci extensions — illustrated on the right — measure impulse waves in the direction of a trend. From the swing XA, the extension AB extends more than 100% of the length of the swing XA. For example, assume the price of a cryptocurrency starts at $100 and goes up to $200 during a first leg. The currency then falls back down to $150 during a second leg. The price movement back down to $150 is a Fibonacci retracement. This movement of the price in the second leg “retraces” half-way back to the original price of $100. If the price then starts to increase and pushes back towards $200, this is an extension of the original price increase from $100 to $200.

All the views expressed on this site are those of Thomas Wettermann and do not represent the opinions of any entity whatsoever with which Thomas Wettermann has been, is currently, or will be affiliated. Trading digital financial assets such as cryptocurrencies can carry a high level of risk, and may not be suitable for all investors. Before deciding to invest, purchase, and/or trade cryptocurrency you should carefully consider your investment objectives, level of experience, adversity to risk and volatilities. The possibility exists that you may sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with cryptocurrency trading, and seek advice from a qualified and independent financial advisor. 

Thomas Wettermann is not an independent financial advisor. Any opinions, news, research, analyses, prices, or other information contained on this website is provided as general market commentary of Thomas Wettermann, and does not constitute investment advice. Thomas Wettermann will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information. All opinions expressed on this site are owned by Thomas Wettermann and should never be considered as advice in any form.