What are the Fibonacci Retracement Levels?

15 October 2021

    The Fibonacci retracement levels are one of the most popular technical analysis methods used in trading. It is a set of static lines drawn between two significant points on a chart, usually a high and a low, at specific levels defined by ratios that can be found in the Fibonacci sequence of numbers. The Fibonacci sequence of numbers is the sequence from which this set of lines has gotten its name from. Fibonacci retracements are used to identify and trade support and resistance levels. 

     

    Fibonacci numbers were invented by Leonardo Fibonacci, an Italian mathematician, and they consist of a sequence of numbers that is calculated by adding together the two previous numbers. See below the first numbers of the Fibonacci sequence.

    1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89….

     

    Fibonacci retracements are drawn at specific price levels which respect the ratios found in the Fibonacci sequence of numbers. The ratios are calculated as follows:

     

    Ratio = Xn-i/Xn

     

    Where 

     

    X = Fibonacci number

    n = Fibonacci sequence index 

     

    These ratios are 23.6%, 38.2% and 61.8%. You can see how they are calculated, taking 89 as an example, below:

     

    55/89 = 0.618

    34/89 = 0.382

    21/89 = 0.236

     

    50% is also used by some traders even though it is not an official Fibonacci retracement. The percentages represent ratios between the two points selected on the chart. For example, if we choose our high point to be 1.12000 and our low point to be 1.11000, the respective Fibonacci levels will be 

     

    0%      = 1.11000

    23.6% = 1.11236

    38.2% = 1.11382

    61.8% = 1.11618

    100%  = 1.20000

    Setting Up Fibonacci Retracement Levels in Fondex cTrader

    Fibonacci retracement levels can easily be drawn on Fondex cTrader, since they are a part of the built-in drawing tools available on Fondex cTrader. The only thing you have to do is to choose the Fibonacci Retracement tool from the line studies tools found beside your cTrader chart. See the image below:

     

     

    After you have selected the Fibonacci retracement tool, the only step left is to pick two points on the chart, in between which the Fibonacci retracement levels will be drawn. After you have selected your points, the relevant Fibonacci levels with appear on the chart like in the screenshot below.

     

    Trading the  Fibonacci Retracement Levels

    The Fibonacci retracement levels are mainly used as a part of trend trading strategies. The main function of a Fibonacci retracement drawing on a chart is to identify the main trend and then mark the price levels at which some resistance or support should be expected in case the price retraces. These levels mark good entry points for traders that believe that the trend will continue in the same direction. The following chart serves as an example of this strategy.

     

     

    The chart above is the daily chart depicting the price movement of EURUSD. As we can see, EURUSD has been on a downward trend for the last three months and has reached a bottom low on 19/08. At this point, a retracement was observed for the following dates. Taking into consideration other factors, such as the fundamentals indicating that this downward trend may continue, we set the Fibonacci retracements on the May’s high and August’s low points, expecting that at some point the price would hit a strong resistance level and then resume its downward move to lower lows.

     

    As we can observe from the price action, the price has breached the resistance level of the first Fibonacci retracement at 23.6%, but eventually stopped rising at 38.2% and the direction continued to lower lows. If we also have a look at the previous lows of this trend, we can confirm that the retracements were halted somewhere near the first Fibonacci level.

     

     

     

    Fibonacci retracement levels are a good tool to identify entry points in the case that you are trading in favor of a trend continuation. However, in the case of an actual trend reversal, Fibonacci levels might lead to wrong conclusions and false signals. Therefore, it is strongly recommended that Fibonacci retracement levels be traded in conjunction with other trend identification techniques e.g. alongside some trend indicators.

     

    A technique that can ideally be combined with Fibonacci retracement levels is moving average Golden Cross/Death Cross strategy. A golden cross occurs when a faster - 50 period moving average crosses above a slower - 200 period moving average from below, and a death cross occurs when a faster - 50 period moving average crosses above a slower - 200 period moving average from above. Below we can see the previous chart combined with a death cross signal, where the death cross confirms that the downtrend is set to continue and that the Fibonacci retracement level is a good level to reenter the market, trading the downward trend.

     

    Limitations of the Fibonacci Retracement Levels

    Fibonacci retracement levels can generate a lot of false signals that could lead to substantial losses if used out of context. Therefore, when using strategies based on Fibonacci retracement levels, always consider the market fundamentals that currently move the market and combine the signals with other confirmation signals, like oscillators, support/resistance levels and the relevant price action taking place on the chart. 


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