Fibonacci Retracement is commonly adopted by the most sophisticated technical traders. When effectively integrated into trading strategies, it can identify potential trends and price actions for any asset. Today, we will guide you through mastering this tool in just 3 minutes with only 3 steps.

What is The Fibonacci Ratio?

Our journey begins with the origins of the Fibonacci sequence, discovered and introduced by the mathematician Leonardo Pisano, also known as Fibonacci, in the 13th century. This sequence is a series of numbers in which each number is the sum of the two preceding ones (e.g., 0, 1, 1, 2, 3, 5, 8, 13, 21, and so on).

One remarkable characteristic of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This consistent relationship between every number in the series forms the basis for the ratios utilized by technical traders to determine retracement levels.

The most commonly used Fibonacci ratio include, 61.8, 50%, 38.2%, and 23.6%.

The key Fibonacci ratio of 61.8% is derived by dividing one number in the series by the number that follows it. For instance, dividing 5 by 8 yields 0.625, and dividing 13 by 21 results in approximately 0.619.

The 38.2% ratio is determined by dividing a number in the series by the number located two positions to the right. For example, dividing 21 by 55 gives us approximately 0.38181

The 23.6% ratio is obtained by dividing one number in the series by the number that is three positions to the right. For instance, dividing 13 by 55 yields about 0.2364.

To enhance visual representation on charts, we will also include numbers that do not adhere to the Fibonacci ratio, such as 50% and 100%, as they serve as useful reference points.

Understanding Fibonacci Retracement Levels

What makes the Fibonacci sequence interesting is its intriguing and unexpected connection to nature, architecture, and even art. Remarkably, it also proves to be highly effective in the trading market.

Fibonacci retracements are the simplest and most applicable trading tools used to establish support and resistance levels, set stop-loss orders, and determine target prices. Fibonacci ratios can even serve as a primary mechanism in counter-trend trading strategies.

Fibonacci retracement levels are horizontal lines that indicate potential support and resistance levels. Each level corresponds to one of the aforementioned ratios or percentages. These levels demonstrate how much of a previous movement the price has retraced.

Take the above chart on Bitcoin as an example, after taking the significant high and low, the indicator will then generate the levels between those two points. We are looking for price to retrace back to range between 50% and 61.8%, which indeed happened on the 15th of June. Therefore, even if the direction of the previous trend is likely to continue, but the price of the asset typically retraces to one of the ratios listed above before doing so.

Applying Fibonacci Retracement Levels in Trading

Now that we have grasped the theory behind Fibonacci retracement levels, let us explore their practical application in trading. A general rule of thumb is to first practice on higher timeframe charts before moving down to hourly or minute charts.

Step 1:

Identify the major high/low. Looking at the USD/JPY Daily chart below, it should not be too difficult to locate.

Step 2:

Connect the two points (major high/low). In TradingView, simply click the “Fib Retracement” tool to automatically draw the required Fibonacci levels after picking the major high and low.

Step 3:

Utilize the Fibonacci levels as support/resistance. A prime example is the 50% to 61.8% retracement level, which acted as a significant support level, preventing the currency pair from breaking through.

For instance, referring to the example above, when the currency pair experiences a drop at the 0.618 level, it signifies a strong tendency for the asset to undergo a reversal. Consequently, traders strategically aim to
purchase at that specific position.

However, it is crucial to acknowledge that assets with high volatility, such as small-cap cryptocurrencies, may not adhere to the expected performance when utilizing Fibonacci levels. Therefore, it is important for traders to conduct thorough research prior to investing in any product or asset.

The Bottom Line

Congratulations! You have now mastered the tool of Fibonacci retracement levels!

Remember, practice makes perfect, so do not hesitate to experiment with Fibonacci retracement levels on your own charts. With time and experience, you will unlock the true potential of this remarkable tool and enhance your trading success.

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Disclaimer: The information provided in this article is for educational purposes only and should not be considered as financial advice. Trading involves risk, and it is important to conduct thorough research and seek professional guidance before making any investment decisions. Prospective investors are encouraged to perform their own due diligence or consult a financial advisor before making investment decisions.