A Comprehensive Guide to Fibonacci Retracements (Updated)

24 mar

Hello traders, in this post, we will be going over one of the most commonly used tools in all asset classes - the "Fibonacci Retracement" (or Fib for short). For a better viewing experience, please view this on your desktop/PC, as the mobile and tablet versions of the charts are harder to read.

Although I have briefly touched on how to use the Fibonacci Retracement tool in my previous Elliott Waves series, we are now going to go over it in depth, and talk about how this tool can help you find entries and exits within an existing trend with or without the use of the Elliott Wave Theory, which also helps identify whether you are in a bullish or bearish trend.

The Fibonacci Retracement tool, although widely used by many traders, is almost always not correctly used by new traders. Most traders will often connect the wrong points, indicating the wrong Fibonacci retracement levels. Here, I will be explaining the proper way to use the Fibonacci Retracement tool in a very simple translated friendly guide in one post.

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What Is the Fibonacci Retracement?
Fibonacci Retracements (Fib(s) for short), are a set of 'ratios', defined by mathematically important Fibonacci sequence. This allows traders to identify key levels of support and resistances for price action. Unlike other indicators, Fibonacci retracements are FIXED, making them very easy to interpret. When combined with additional indicators, Fibs can be used to identify potential entry and exit points with high probability to trade on trending movements. Fibonacci retracements are used to indicate levels of support and resistance for a stock’s price. Although they are similar to moving averages in this respect, Fibonacci retracements are set by the extent of the previous bullish or bearish run and do not change each day in the current trend as moving averages do. Therefore, it can be significantly easier to identify and anticipate support and resistance levels from Fibonacci sequences.

How Is the Fibonacci Retracement Calculated? (You don't need to calculate it yourself - It's already done for you!)
Fibonacci retracements are based on what is known as the 'Fibonacci sequence', where each number in the sequence can be added to the previous number to produce the following number within the sequence. Now, you might be confused here, but don't! - I am just explaining the concept on how it's calculated. You do not need to personally calculate the actual sequence of the Fibonacci Retracement, as everything is already pre-determined and calculated within the tool itself on TradingView. To put it simply, dividing any number in the sequence by the following number yields 1.6180 – known as the "Golden Ratio" – while dividing any number by its predecessor yields 0.6180. Dividing any number in the sequence by two positions in advance yields 0.382, while dividing any number by a number three positions in advance yields 0.236. These ratios originated from the Fibonacci sequence are found throughout nature, mathematics, and architecture - such as flowers, buildings, and so forth. Yes, if you search for Fibonacci sequence examples, you can find these within daily uses, not only in trading.

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Retracement levels for an asset are drawn based on the prior bearish or bullish movement. Don't forget this - you need to know whether you are in a bullish or bearish trend. Is the stock or coin going up? or down? To plot the retracements, draw a trendline from the low to the high (also known as the swing low to the swing high), or vice versa, high to low, within a continuous price movement trend – Fibonacci retracement levels should be placed at 61.80%, 38.20%, and 23.60% of the height of the line for you by the tool itself. Again, these numbers are already calculated for you within the tool itself. In a bullish trend, the retracement lines start from the top of the movement (i.e. the 23.60% line is closest to the top of the movement), whereas in a bearish movement the retracements are calculated from the bottom of the movement (i.e. the 23.60% line is closest to the bottom of the movement).

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How to Trade Using the Fibonacci Retracement
Once you have drawn a set of Fibonacci retracements on a chart of your liking, it is possible to anticipate potential reversal points where support or resistance will be encountered. If the retracements are based on a bullish trend, the retracements should indicate potential support levels where a downtrend will reverse bullishly. So to put it simply, the pre-determined Fibonacci levels, should in theory and practicality, act as support if in a bullish trend, and resistance in a bearish trend.

There will always be some form of price reaction at each Fibonacci level just based on Market Psychology. If the retracements are based on a bearish movement, the retracements should indicate potential resistance levels where a rebound will be reversed bearishly, which is vice-versa for the bullish movement trend.

The most common reversals based on Fibonacci retracement levels occur at the 38.20%, 50%, and 61.80% levels (50% comes not from the Fibonacci sequence, but from the theory that on average, stocks retrace half of their prior movements - so this is considered a 'psychological level'). Although retracements do occur at the 23.60% line, these are less frequent and require close attention since they occur relatively quickly after the start of a reversal. In general, retracement lines can be considered stronger support and resistance levels when they coincide with the overall trend, meaning, that if you know that you are in an established bullish or bearish trend, you will most certainly get some form of reaction at the most common reversal levels within the Fibonacci level, which is shown in the image below.

Whenever applying Fibonacci retracements, keep in mind that retracement lines represent only potential support and resistance levels, they are NOT 100% set in stone – they represent price levels at which to be alert, rather than hard buy and sell signals; however, they have HIGH PROBABILITY. It is important to use additional indicators, in particular MACD, to identify when support or resistance is actually being encountered and a reversal is likely. The more that additional indicators are pointing towards a reversal, the more likely one is to occur. Also note that failed reversals, especially at the 38.20% and 50% retracement levels, are common.