Fibonacci retracement levels are sequential ratio numbers used to identify potential reversals in price action. These ratios can be found all around in nature and culture. The financial markets are not an exception. The Fibonacci retracement tool is often used with other technical analysis indicators to find levels of confluence.
The key retracement levels are:
- 23.6% retrace – shallow retrace
- 38.2% – 50% retrace – moderate retrace
- 61.8% retrace (golden retrace) – deep retrace
- 78.6% – 88.6% retrace – deepest retrace
The 23.6% retrace is used to identify that the price has hit its swing high. Fibonacci should be used only if the price has pulled back 23.6%. Price will then most commonly retrace to 38.2% – 61.8%.
The most common retrace zone is 38.2% – 61.8%. This is called the golden zone.
The 50% retrace is not an actual Fibonacci sequential number. It is from Dow’s Theory, where he states that after an impulse we most commonly retrace half of the move, before continuing the primary trend.
The 61.8% golden retrace is the reciprocal of the 1.618 Fibonacci Extension which is the golden ratio (represented by the Greek letter phi ϕ), which is a very important ratio in mathematics.
To draw a Fibonacci retracement in an uptrend:
From left to right, start with the swing low point and drag the cursor up to the swing high point. The tool will automatically show the Fibonacci levels based on these two points. You can then strategise target price levels. A rule of thumb is you must draw from either the wick to wick or candle body to candle body. You cannot mix the two.
To draw a Fibonacci retracement in a downtrend:
A downtrend is just the opposite of an uptrend. From left to right, start with the swing high point and drag the cursor down to the swing low point. The tool will automatically show the Fibonacci levels based on these two points. You can then strategise target price levels. A rule of thumb is you must draw from either the wick to wick or candle body to candle body. You cannot mix the two.
