Fibonacci retracement levels are probably one of the most popular and well-known overlay indicators in technical analysis.
They represent hidden barriers to price action and identify possible turning points of Support and Resistance in the market.
Fibonacci Numbers and Sequence
The history behind Leonardo Fibonacci numbers, series and ratios has something mystical. The so-called Fibonacci golden ratio indeed, can be found in several natural aspects, from flowers to galaxies.
Here in this article I don’t want to bore you about the mathematical derivation of these number. Therefore, just remember that Fibonacci retracements depends on the famous golden ratio (phi).
Every single day, thousands of institutional and retail traders take buy and selling decisions based on these levels. Thus, you need to know what these retracements are and how to use them.
Fibonacci retracement levels: hidden support and resistance levels
Fibonacci retracement identify relevant areas of support and resistance. They are horizontal levels drawn between a swing low (A) and a swing high (B) and identify the percentage of retracement of price action compared to previous impulse (AB):
The most important and traded Fibonacci retracement levels are:
- 23,6% of AB impulse;
- 38,2% of AB impulse;
- 61,8% of AB impulse – by far the most important level of Fib retracement;
- 78,6% of AB impulse;
The level equal to 50% retracement of AB impulse, is also considered important, even though not based on Fibonacci sequence.
Mysticism or not, Fibonacci retracements works in real-life world. This is a perfect example of Self-fulfilling prophecy “a belief or expectation that an individual holds about a future event that manifests because the individual holds it” (definition by positivepsychology.com).
Since every single trader is perfectly aware about the existence of these levels, these last are heavily traded and price tends to react to these relevant areas.
Fibonacci retracement levels in uptrends and downtrends
Fibonacci retracements work in downtrends as well as in uptrends. The only difference regards the drawing method:
- In an uptrend, we draw Fibonacci retracements from a swing low to a swing high;
- In a downtrend, we draw Fibonacci retracements from a swing high to a swing low;
Here below two examples:
You don’t have to draw Fibonacci retracement levels manually!
Luckily for us, software and websites like tradingview.com provide free technical analysis tools and indicators to calculate retracements in any market, including forex.
To calculate Fibonacci resistance and support levels just go on a chart in tradingview.com. Then, on the left toolbar, select the Fib retracement tool:
Now, draw Fibonacci retracements between a significant swing low and a significant swing high. You can also customize the appearance of the indicator, by clicking on the settings icon which appear when you select the indicator:
How to use Fibonacci retracement to find entry points in forex, crypto and stock markets
There are several common uses of retracements in Fibonacci trading.
First and foremost, they provide identification of potential turning points in the market, whenever we are talking about an uptrend, downtrend or even a consolidation phase.
Also, Fibonacci retracements may spot potential targets or stop losses, helping traders to protect their positions, increasing at the same time the risk-to-reward ratio.
How to use Fibonacci retracements to enter in pro-trend trade
Markets, including Forex and Crypto ones, move either in impulses (toward main trend direction) or in pullbacks (against main direction).
Pullbacks are “halts” in price action: they are considered a healthy signal, since they represent on chart the take profit activities of market traders. Their absence indeed, may cause a sharp “sell-off” and a sudden fall in price once all the selling orders are triggered together.
Using Fibonacci retracements, we can forecast on an early basis where pullbacks may actually end. Thus, Fibonacci levels may help us in finding potential reversal zones (PRZ). These areas constitute turning points in which price action may resume the rally on its main direction.
Look at the example below about Bitcoin:
As you can see, in point B price start to fall, until it reaches the 61,8% Fibonacci level. Here, price test the level 3 times before to resume the uptrend.
Notice that by entry at the 61,8% retracement level, you can enter in the trade with a risk-to-reward ratio grater than any other Fibonacci level drawn from AB impulse.
Fibonacci trading on multiple timeframes
Generally, in technical analysis the more a price level is clear and evident, the more this last is reliable for your analysis. That’s true even for Fibonacci retracements.
Levels spotted on weekly or daily timeframes, usually are more reliable than ones identified on lower timeframes.
For that reason, a good strategy to improve the overall success rate of your trades is to combine the “big picture” with the operative one:
Conclusions – key takeaways
In this article, we’ve discussed about Fibonacci retracements, a technical analysis overlay indicator used to identify relevant turning points in forex and financial markets. So, let’s remark the main takeaways learned today:
- Fibonacci retracement levels are overlay indicators widely employed in technical analysis;
- These levels represent hidden support and resistance zones;
- The most commonly used Fibonacci ratios are 23.6% – 38.2% – 50% – 61.8% (by far the most important one) – 78.6%;
- Retracements can be drawn both in uptrends and downtrends;
- They can be used to fix targets and stop losses;
- Fibonacci ratios and numbers are the basis of harmonic patterns like Bat, Butterfly and Gartley;
- Retracements may provide excellent pro-trend entries either in forex or crypto markets;
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