The Fibonacci retracement tool has become a relatively popular technical indicator amongst forex traders, primarily due to the way it can easily help users to spot the interaction between corrective and trending movements in the forex market. Fibonacci retracement levels are horizontal lines that indicate where potential support and resistance levels can occur. Each of these price levels are based on the Fibonacci numbers and a percentage. The percentage is how much the price has retraced from the previous market movement. The indicator is useful for creating Fibonacci levels between two significant price points chosen by the user, usually market highs and lows.
What are Fibonacci retracements in trading?
The forex Fibonacci retracement levels can be entirely subjective depending on the trader marking them. However, due to the popularity of Fibonacci tools, they can often have a self-fulfilling prophecy. The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%.
If you apply these ratios in any direction following a trend, then you can spot potential areas where the trend will continue or reverse. Fibonacci trading strategies can be improved when combined with other forms of technical and price action analysis. For example, when working with a Fibonacci retracement grid, it can be beneifical to utilise moving averages in order to confirm trading signals and analyze market lows and highs.
How to trade Fibonacci retracement levels?
The main purpose of using the Fibonacci retracement tool to mark levels on your chart is to try and determine possible support and resistance levels. In the case where the Fibonacci retracement levels already represent existing support or resistance, the possibilities of price rebounding from these areas can increase. Look at the chart below where 38.2% and 50% levels coincide with the support lines:
Fibonacci retracement levels can be used to enter into a trend when price breaks through one of the support or resistance levels. They can also be used to trade reversals in a range bound market. You could implement a moving average to help spot trending market conditions whereas an overbought/oversold technical indicator such as the Stochastic Oscillator can help spot range bound market conditions.
To market Fibonacci retracement levels on your chart you will need to use the Fibonacci retracement tool that is usually included in the best forex trading platforms such as MetaTrader. To do this, pull the Fibonacci retracement levels from a recent high to a recent low or vice versa. You can then use the resulting levels as resistance or support levels for breakout or reversal trading. They can also be used for placing stop loss and take profit targets.
You can also mark the Fibonacci retracement levels using price action formation such as double tops or simply apply them to the recent highs and lows on your chart. Keep in mind that the levels can be different depending on the chart time frame that you are using. Some traders will even market the Fibonacci retracement levels on multiple time frames. I personally find that can clutter up my charts and I would much prefer to use higher time frame charts as I believe they can filter out some of the noise that can occur in the shorter-term time frames. This also means I need to spend less time staring at charts waiting for trading signals. You can even set price alerts around the key Fibonacci retracement levels so you get sent an email or push notification once price reaches those levels.
Fibonacci retracement trading strategy
Fibonacci retracement lines can be created when you divide the vertical distance between the high and low points by the key Fibonacci ratios. Horizontal lines are drawn on the trading chart at the 23.6%, 38.2% and 61.8% retracement levels. Some traders also like to use the 50.0% ratio.
Fibonacci Expansions and Fibonacci Extensions can be a great leading forex indicator of price targets once a Retracement level is honored. Deciding which tool to use is a personal choice for price targets as both methods have their benefits.
In this example, we will follow a simple trade setup using the Fibonacci retracement levels as price reversal zones. Further confirmation can be added by using moving averages and manually drawing support and resistance areas.
Fibonacci retracement buy signal
- Draw the levels by connecting swing low to the swing high.
- Wait for the price to halt at 23.6, 38.2 or 50.00 levels. High probability entry is if the price retraces to 100.00 making a double bottom.
- Buy if the closed candle is bullish.
- Mark the stop-loss slightly below the local low.
- Mark the exit at the next Fibonacci level on the upside.
Fibonacci retracement sell signal
- Draw the levels by connecting swing high to the swing low.
- Wait for the price to halt at 23.6, 38.2 or 50.00 levels. High probability entry is if the price retraces to 100.00 making a double top.
- Sell if the closed candle is bearish.
- Mark the stop-loss slightly above the local high.
- Mark the exit at the next Fibonacci level on the upside.
Fibonacci retracements conclusion
In this trading guide we have learned what the Fibonacci retracement indicator is, studied its description and capabilities. We have learned that the Fibonacci retracement levels are commonly used to draw resistance and support lines on charts.
Fibonacci retracement levels are marked between the beginning and end of the price movement, the levels are corrective, and show what levels the price can return to. It is also important to remember that Fibonacci retracements are primarily used on the price chart from left to right for downtrends and uptrends.
Some experts believe that Fibonacci retracements can forecast about 70% of market movements, especially when a specific price point is predicted. However, some critics say that these are levels of psychological comfort rather than hard resistance levels.
Trading with Fibonacci retracement levels is flexible and they can be implemented into differing market conditions, thus can be used as part of a forex trend trading strategy and forex range trading strategy. However, Fibonacci retracement levels are not 100% accurate just as with any other technical indicator, there can be false signals.
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