The Fibonacci Retracement is an indicator used to find technical levels on a tradeable asset. Using fibonacci traders can identify potential areas to enter a position, set a stop loss and set a target price. The fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8% and 78.6%. This guide will explain how fibonacci are typically used.
Drawing The Fibonacci Retracement Tool
In an uptrend the fibonacci tool is drawn by connecting the recently formed low (swing low) to the most recent high (swing high). In theory, the fibonacci is drawn like this:
On a live chart it can be difficult to identify the areas to draw a fibonacci retracement tool. In practice, this is how the fibonacci tool looks:
As you can see on this chart, AUDUSD is in an uptrend as it is forming higher lows and higher highs. To draw the fibonacci we connect the swing low point to the swing high.
In a downtrend the fibonacci is drawn similarly but in reverse, connecting the lower high to the new lower low. It looks like this:
In practice the fibonacci retracement tool looks like this in a downtrend:
Now that you know how to draw the fibonacci retracement tool lets see how it works.
Support And Resistance With Fibonacci
Using the previous examples, lets see how the fibonacci levels are significant as support and resistance. For the first example, in the uptrend we can see price found support at the 78.6% level. The bullish candle closed above this fibonacci level, showing that buyers have now stepped in to control price.
Typically traders looking for long positions would see this as confirmation to enter, as support has now formed, creating a new higher low in an uptrend.
In the previous downtrend example we can see that price has found a resistance at the 61.8% retracement level, selling aggressively out of this level.
As these examples have shown, fibonacci levels can be quite helpful at finding support and resistance levels. Traders typically use these fibonacci levels to find an entry opportunity for trading with the trend.
Stop Loss Placement Using Fibonacci
Once a support or resistance has been formed on a fibonacci retracement level, traders will typically look for the next fibonacci level to place a protected stop loss. For example, if in an uptrend a support is formed at the 78.6% level, the trader will place the stop at the 100% retracement as this is the next level. This is demonstrated below.
The same applies for a downtrend. If price forms a resistance at the 61.8% level, traders would then typically look to place a stop loss at the 78.6% fibonacci level. An example of this is shown below.
Placing Target Price Using Fibonacci
Typically fibonacci level traders look to target three levels. These are the 0% retracement (previous high in an uptrend or previous low in a downtrend), the -0.27% retracement and the -0.618% retracement. Using our previous examples, we can see how these Target prices have been set and reached, using the fibonacci retracement tool.
This example has shown how the fibonacci tool can be used effectively to set target prices.
The fibonacci retracement indicator can be effectively used to find support and resistance levels, placing stop losses, and finding target prices. Whilst the fibonacci retracement indicator is an effective indicator, no indicator is fail proof and it is important for traders to do their own experiments using it to gather data on the probability of its success.