How to Use Fibonacci Retracement - Fibonacci Retracement Levels

In the world of technical analysis, markets rarely move in a straight line. Instead, they move in a series of impulses and corrections. To capitalize on these movements, traders use specialized tools to predict where a correction might end and the primary trend will resume. Among the most widely respected of these tools is Fibonacci retracement, a method that uses mathematical ratios to identify hidden psychological floors and ceilings in price action.

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Key Moments

Fibonacci retracement is a technical analysis tool that uses percentages and horizontal lines, these lines are drawn onto price charts, to identify possible areas of support and resistance.
Fibonacci retracement analysis can be used to confirm entry level and determine stop-loss level.
Fibonacci retracement levels are 23.6%, 38.2%, 61.8% and 78.6% (50% is used as well as a level, yet unofficially).
There are two ways to use retracement levels for entries; entering at each level, or waiting for the price to go back in the original direction first.

What is Fibonacci Retracement

Fibonacci Retracement is a technical analysis tool used by traders to identify potential levels of support and resistance based on the mathematical sequence discovered by Leonardo Fibonacci. In a trading context, the tool creates horizontal lines on a price chart at key percentage intervals. These lines suggest areas where the price may "retrace" or pull back before continuing in the original direction of the trend.

How to Use Fibonacci Retracement

To use Fibonacci retracement effectively, a trader must first identify a distinct price move, known as a "trend" or "swing". The tool is most reliable when the market is trending strongly, as it helps traders find high-probability entry points during temporary price dips.

Steps to Apply Fibonacci Retracement:

1. Identify the Trend

Determine if the market is in a clear uptrend (higher highs) or downtrend (lower lows).

2. Select the Swing Points

In an uptrend, select the Swing Low (the start of the move) and drag the tool to the Swing High (the peak). In a downtrend, drag from the Swing High to the Swing Low.

3. Analyze the Levels

Observe how the price reacts as it touches the generated horizontal lines. Look for candlestick reversal patterns or increased volume at these levels.

4. Confirm with Other Indicators

Use oscillators or moving averages to confirm that the retracement is likely ending.

Note: 61.8%, 50.0%, 38.2% are potential long entry levels

The Fibonacci tool is applied manually. When measuring a downtrend, you need to apply the tool at the start of the move to the end – it is always applied from left to right. The tool is drawn starting at the top and ends at the bottom, drawn from left to right. You can see from the chart below;

For upward movement, the tool is applied at the bottom and ends at the top - again, it is always applied from left to right. Check out the graph:

What are Fibonacci Retracement Levels

Fibonacci Retracement Levels are specific percentage-based horizontal lines—primarily 23.6%, 38.2%, 61.8%, and 78.6% - that indicate where a price correction might stall.

While the 50% level is not technically a Fibonacci ratio, it is almost always included in the tool because markets frequently retract half of a major move before finding support or resistance.

The 61.8% level is often referred to as the "Golden Ratio," representing the most significant area for potential trend reversals.

How to Calculate Fibonacci Retracement Levels

The levels themselves are derived from the Fibonacci sequence (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144...). The key ratios are found by dividing numbers within this sequence:

61.8%: Calculated by dividing a number in the sequence by the number immediately following it (e.g., 89 / 144 = 0.618).
38.2%: Calculated by dividing a number in the sequence by the number two places to the right (e.g., 55 / 144 = 0.3819).
23.6%: Calculated by dividing a number in the sequence by the number three places to the right (e.g., 34 / 144 = 0.2361).

To find the actual price level on a chart, the formula uses the price range (the difference between the High and Low):

Price (Level) = High - (Range X Percentage)

For example, if a stock rises from $100$ to $200$, the range is $100$. The 61.8% retracement level would be:

200 - (100 X 0.618) = $138.20

How to Trade with Fibonacci

Fibonacci retracement levels are most effective when used within a broader strategy, with a combination of several indicators there is a higher chance to more accurately identify market trends. The more factors backing the situation in the market the better.

Fibonacci levels can be used in many different trading strategies, for example:

Using Fibonacci retracement lines with the MACD indicator. When a security’s price touches an important Fibonacci level a position can be opened in the direction of the trend.
Using Fibonacci levels with the Stochastic indicator. This two-line indicator can help identify overbought and oversold levels. The strategy looks for a key signal from the stochastic indicator when the price touches an important Fibonacci level.
Fibonacci retracement levels can be used across multiple timeframes, but are considered to be most accurate across longer timeframes.

Fibonacci levels can be useful if you want to buy a particular security but missed a recent uptrend. In this situation, you can wait for a rollback. By charting Fibonacci ratios such as 61.8%, 38.2% and 23.6%, you can identify possible retracements and open potential trading positions.

Conclusion

The Fibonacci approach shouldn't be used solely, traders need to use it in combination with other technical analysis tools. That way they will have a fuller picture of the situation in the market. This approach can give an extra level of insight to potential market turning points. Fibonacci retracement levels can be used to make trading decisions in the same way as normal horizontal support and resistance levels.

Remember these levels are best used as a tool within a broader strategy…

Fibonacci Retracements are a guide

You can apply Fibonacci Retracement tool on any timeframes, use it to see how far a pullback is likely to retrace after another trending wave begins. Remember, there is no guarantee the price will stop at a level just because it is shown on the chart.

Forex Indicators FAQ

What is a Forex Indicator?

Forex technical analysis indicators are regularly used by traders to predict price movements in the Foreign Exchange market and thus increase the likelihood of making money in the Forex market. Forex indicators actually take into account the price and volume of a particular trading instrument for further market forecasting.

What are the Best Technical Indicators?

Technical analysis, which is often included in various trading strategies, cannot be considered separately from technical indicators. Some indicators are rarely used, while others are almost irreplaceable for many traders. We highlighted 5 the most popular technical analysis indicators: Moving average (MA), Exponential moving average (EMA), Stochastic oscillator, Bollinger bands, Moving average convergence divergence (MACD).

How to Use Technical Indicators?

Trading strategies usually require multiple technical analysis indicators to increase forecast accuracy. Lagging technical indicators show past trends, while leading indicators predict upcoming moves. When selecting trading indicators, also consider different types of charting tools, such as volume, momentum, volatility and trend indicators.

Do Indicators Work in Forex?

There are 2 types of indicators: lagging and leading. Lagging indicators base on past movements and market reversals, and are more effective when markets are trending strongly. Leading indicators try to predict the price moves and reversals in the future, they are used commonly in range trading, and since they produce many false signals, they are not suitable for trend trading.