Fibonacci retracement levels are a popular tool used by traders to identify potential support and resistance areas in price charts.
These levels are based on the Fibonacci sequence, a series of numbers where each number is the sum of the two preceding ones. In trading, Fibonacci retracements help predict where a price might pause or reverse during a trend.
Let’s break down how Fibonacci retracements work and how you can use them in your trading strategy.
What are Fibonacci Retracement Levels?
Fibonacci retracement levels are horizontal lines on a price chart based on key Fibonacci ratios (23.6%, 38.2%, 50%, 61.8%, 78.6%). They indicate potential support and resistance areas where price might reverse during a trend. For example, a 38.2% retracement means the price has pulled back 38.2% from its previous trend.
| Fibonacci Ratio | Percentage |
| 0.236 | 23.6% |
| 0.382 | 38.2% |
| 0.5 | 50% |
| 0.618 | 61.8% |
| 0.786 | 78.6% |
How to draw Fibonacci Retracement Levels
To draw Fibonacci retracement levels on a chart:
- Identify a clear uptrend or downtrend
- Select the trend’s starting point (swing low for uptrends, swing high for downtrends)
- Drag the Fibonacci retracement tool to the opposite end of the trend
- The tool will automatically draw horizontal lines at the key Fibonacci levels
Most trading platforms have a built-in Fibonacci retracement tool, making it easy to apply to your charts.
Using Fibonacci Retracements in Trading
Traders use Fibonacci retracements to:
- Identify potential reversal points
- Set entry points for trades
- Place stop-loss orders
- Set price targets for taking profits
For example, in an uptrend, a trader might look to buy when the price pulls back to a Fibonacci support level. In a downtrend, they might look to sell when the price rallies to a Fibonacci resistance level.
Combining Fibonacci retracements with other Indicators
Fibonacci retracements are most effective when used with other technical analysis tools. Here are some popular indicators to combine with Fibonacci levels:
Moving averages
Moving averages help smooth out price action and identify trends. When a Fibonacci level aligns with a key moving average, it can create a stronger support or resistance zone.
Relative strength index (RSI)
The relative strength index (RSI) measures momentum and can help confirm whether a price is likely to reverse or continue its trend at a Fibonacci level.
MACD (Moving Average Convergence Divergence)
The MACD (Moving average convergence divergence) indicator can signal potential trend changes when price reaches a Fibonacci level.
Bollinger bands
Bollinger bands can help identify volatility and potential reversal points. When Fibonacci levels coincide with Bollinger band touches, it can create high-probability trade setups.
Fibonacci Retracements in Different Markets
Fibonacci retracements can be applied to various financial markets:
- Stocks
- Forex
- Commodities
- Cryptocurrencies
The principles remain the same across all markets, but the effectiveness may vary depending on the specific asset and timeframe.
Advantages of using Fibonacci Retracements
- Easy to use and widely available on trading platforms
- Provides objective price levels for potential reversals
- Can be applied to any timeframe
- Works well with other technical analysis tools
Limitations of Fibonacci Retracements
- Subjective in choosing start and end points
- May not work as well in ranging or choppy markets
- Can create too many potential support/resistance levels
- Requires confirmation from other indicators or price action
Tips for using Fibonacci Retracements Effectively
- Use Fibonacci levels in conjunction with other technical analysis tools
- Look for confluence between multiple Fibonacci levels and other support/resistance areas
- Be patient and wait for price action confirmation before entering trades
- Practice on demo accounts before using real money
- Keep your charts clean and focus on the most important levels
Fibonacci Extensions: Taking it Further
Fibonacci extensions are similar to retracements but extend beyond the 100% level of the previous move. They’re used to project potential profit targets in trending markets. Common Fibonacci extension levels include 127.2%, 161.8%, 261.8% Traders often use these levels to set take-profit orders or identify areas where a trend might lose momentum.
Fibonacci Time Zones
Fibonacci time zones apply the Fibonacci sequence to time rather than price. They’re used to predict potential turning points in the market based on time intervals.
While less common than retracements and extensions, Fibonacci time zones can provide additional insights when combined with other Fibonacci tools.
Fibonacci Fans and Arcs
Fibonacci fans and arcs are variations that apply Fibonacci ratios to both price and time. They create diagonal lines or curved lines on a chart, which can identify potential support and resistance areas.
These tools are more advanced and require practice to use effectively.
Common mistakes when using Fibonacci Retracements Levels
- Relying solely on Fibonacci levels without considering other factors
- Choosing the wrong swing high and low points
- Overcomplicating charts with too many Fibonacci levels
- Ignoring the overall market context and trend
- Entering trades without waiting for confirmation
Fibonacci Retracements Levels in Crypto Trading
Cryptocurrency markets, known for their volatility, can be particularly well-suited for Fibonacci retracement analysis. The 24/7 nature of crypto trading and the influence of global traders make Fibonacci levels interesting points of reference.
When trading crypto with Fibonacci retracements:
- Be aware of key psychological levels (e.g., round numbers) that may coincide with Fibonacci levels
- Consider using longer timeframes for more reliable signals
- Pay attention to market sentiment and fundamental factors alongside technical analysis
Building a Fibonacci-based Trading Strategy
To create a trading strategy using Fibonacci retracements:
- Identify the overall trend
- Draw Fibonacci retracement levels
- Look for confluence with other technical indicators
- Wait for price action confirmation at key levels
- Set stop-loss orders below (for longs) or above (for shorts) the relevant Fibonacci level
- Use Fibonacci extensions to set profit targets
Remember, no strategy is foolproof. Always manage your risk and be prepared to exit trades if the market moves against you.
Backtesting Fibonacci Strategies
Before using any trading strategy with real money, it’s crucial to backtest it. Backtesting involves applying your strategy to historical price data to see how it would have performed.
Many trading platforms offer backtesting features. When backtesting a Fibonacci-based strategy:
- Test across different market conditions (trending, ranging, volatile)
- Use a large sample size of trades
- Consider transaction costs and slippage
- Analyze both winning and losing trades to refine your approach
Fibonacci Retracements and Risk Management
Proper risk management is crucial when using Fibonacci retracements. Here are some tips:
- Never risk more than 1-2% of your trading account on a single trade
- Use stop-loss orders consistently
- Consider scaling into positions at different Fibonacci levels
- Take partial profits as price reaches your targets
- Be prepared to exit trades if the market structure changes
Conclusion: Mastering Fibonacci Retracements
Fibonacci retracements are a powerful tool in a trader’s arsenal. When used correctly and in conjunction with other analysis techniques, they can provide valuable insights into potential market turning points.
Remember, successful trading is about more than just indicators. It requires discipline, patience, and continuous learning. As you incorporate Fibonacci retracements into your trading, focus on developing a well-rounded approach that considers multiple factors and prioritizes risk management.
By mastering Fibonacci retracements and combining them with other technical analysis tools, you’ll be better equipped to navigate the complex world of financial markets.
Frequently Asked Questions
What is the best Fibonacci retracement level?
- Which Are the Best Fibonacci Retracement Settings? The most commonly-used Fibonacci retracement levels are at 23.6%, 38.2%, 61.8%, and 78.6%
Is Fibonacci retracement a good strategy?
Fibonacci trading tools, however, tend to suffer from the same problems as other universal trading strategies, such as the Elliott Wave theory. That said, many traders find success using Fibonacci ratios and retracements to place transactions within long-term price trends.
How to set Fibonacci retracement levels?
- We can create Fibonacci retracements by taking a peak and trough (or two extreme points) on a chart and dividing the vertical distance by the above key Fibonacci ratios. Once these trading patterns​ are identified, horizontal lines can be drawn and then used to identify possible support and resistance levels.
What are the Fibonacci take profit levels?
- The most commonly used Fibonacci extension levels are 138.2 and 161.8. The rules for take profit orders are very individual, but most traders use it as follows: A 50, 61.8 or 78.6 retracement will often go to the 161 Fibonacci extension after breaking through the 0%-level.