Fibonacci Retracement

Fibonacci retracement is a popular tool in technical analysis used by traders to identify potential levels of support and resistance. It is based on the Fibonacci sequence, a series of numbers discovered by mathematician Leonardo Fibonacci in the 13th century.

These numbers form specific ratios that are used to predict potential reversal points in the price of an asset.

The tool plots horizontal lines at key levels based on the following ratios:

• 0% – starting point (beginning of the move)
• 23.6%
• 38.2%
• 50% (not a Fibonacci ratio but commonly included by traders)
• 61.8%
• 78.6%
• 100% – end point (end of the move)

These levels indicate where the price could potentially reverse or find support or resistance. Traders use them to estimate possible reversal points during an uptrend or downtrend.

To use the Fibonacci retracement tool, traders typically select two extreme points in a price move: a high and a low. This could be a significant peak and trough in an uptrend or downtrend.

In an uptrend the low point is marked as 0%, and the high point is marked as 100%. In a downtrend, the high point is marked as 0%, and the low point is marked as 100%.

Once these points are identified, Fibonacci retracement levels are drawn within the price range between the two points, helping traders estimate where the price might retrace (reverse or pause) during a correction.

How to apply Fibonacci retracement?

1. Identify a significant price move: look for a large upward or downward price move, either a swing high or low;
2. Select two extreme points: in an uptrend, choose the lowest point (0%) and the highest point (100%). In a downtrend, choose the highest point (0%) and the lowest point (100%);
3. Draw the Fibonacci retracement: the tool will automatically plot horizontal lines at key Fibonacci levels (e.g., 23.6%, 38.2%, 50%, 61.8%) within the price range.

These lines act as potential areas where the price may experience support (in an uptrend) or resistance (in a downtrend).

Traders often combine Fibonacci retracement with other technical indicators, such as moving averages, trendlines, or RSI (Relative Strength Index), to increase the reliability of signals.

For example, if the price retraces to the 50% Fibonacci level and the RSI shows oversold conditions, this may be considered a stronger signal to buy.

Here is an example. The EUR/USD currency pair is in an uptrend, moving from 1.1000 to 1.2000 before pulling back. A trader wants to identify potential support levels where the price might bounce back up.

Firstly the trader would need to identify the swing high and swing low. In this case, swing low is 1.1000 while swing high is 1.2000.

Then they may apply Fibonacci retracement levels (from the high to the low):

• 23.6% level: 1.1764
• 38.2% level: 1.1618
• 50.0% level: 1.1500
• 61.8% level: 1.1382
• 78.6% level: 1.1236

After this, trader can identify the trading opportunities.

While Fibonacci retracement levels are widely used, it is important to remember that these levels are not always precise. Markets do not always follow Fibonacci levels exactly, and retracements can overshoot or undershoot these levels.

Therefore, it is crucial to use Fibonacci in conjunction with other analysis tools and risk management techniques to make more informed trading decisions.