Let me now discuss Fibonacci retracement levels.
Fibonacci retracement levels are horizontal lines that represent potential support and resistance levels where price may reverse direction.
The first thing to understand about the Fibonacci tool is that it is most effective when the market is trending.
When the market is going UP, the strategy is to go long (or purchase) on a retracement to a Fibonacci support level.
And, when the market is going DOWN, to go short (or sell) on a retracement at a Fibonacci resistance level.
Fibonacci retracement levels are regarded as a predictive technical indicator since they attempt to forecast where the price will be in the future.
According to the theory, once a new trend direction is established, the price would retrace or return partially to a previous price level before continuing in the trend’s direction.
Finding Fibonacci Retracement Levels
To determine these Fibonacci retracement levels, you must first locate the most recent important swing highs and swing lows.
Then, for downtrends, click on the Swing High and drag the mouse to the most recent Swing Low.
Do the inverse for uptrends. Drag the cursor from the Swing Low to the most recent Swing High.
Have you gotten that?
Let’s look at some examples of how to use Fibonacci retracement levels in the currency markets.
This is a daily chart of AUD/USD.
We plotted the Fibonacci retracement levels here by clicking on the April 20 swing low at.6955 and moving the cursor to the June 3 swing high at.8264.
Tada! The retracement levels are calculated and shown automatically by the charting program.
The Fibonacci retracement levels were.7955 (23.6%),.7764 (38.2%),.7609 (50.0%*),.7454 (61.8%), and.7263 (76.4%), as shown in the chart.
The anticipation now is that if the AUD/USD retraces from its recent high, it will find support at one of those Fibonacci retracement levels, because traders will place buy orders at these levels as the price falls.
*The 50.0% ratio is not an actual Fibonacci ratio, but it infiltrated the group and has never left.
Let’s take a look at what transpired after the Swing High.
Price fell right through the 23.6% mark and proceeded to fall over the next few weeks.
It even tested 38.2% but was unable to fall below it.
Later, around July 14, the market resumed its upward trend and broke through the swing high.
Buying at the 38.2% Fibonacci level would have undoubtedly been a profitable long-term trade!
Let’s look at how we’d use the Fibonacci retracement tool during a decline. The EUR/USD 4-hour chart is shown below.
As you can see, we discovered our swing high on January 25 at 1.4195 and our swing low a few days later on February 1 at 1.3854.
1.3933 (23.6%), 1.3983 (38.2%), 1.4023 (50.0%), 1.4064 (61.8%), and 1.4114 (76.4%) are the retracement levels.
If the price retraces from this low, it may face resistance at one of the Fibonacci levels since traders looking to play the decline at better prices may be prepared with sell orders there.
Let us now examine what happened next.
The market attempted to rise and briefly halted below the 38.2% level before testing the 50.0% level.
You could have made some serious pips on that trade if you had some orders at the 38.2% or 50.0% levels.
In both of these situations, price found momentary forex support or resistance at Fibonacci retracement levels.
Because of everyone who uses the Fibonacci tool, those levels become self-fulfilling levels of support and resistance.
If a sufficient number of market participants feel that a retracement will occur near a Fibonacci retracement level and are ready to open a position when the price hits that level, all of those pending orders may have an impact on the market price.
One thing to keep in mind is that price does not always bounce back from these levels. They should be considered as potential areas of interest.
For the time being, one thing to keep in mind when utilizing the Fibonacci tool is that they are not always easy to utilize!
If it were so easy, traders would always place their orders at Fibonacci retracement levels, and the markets would continue to trend indefinitely.
In the following lesson, we’ll look at what happens when Fibonacci retracement levels fail.
Next Lesson: Fibonacci Retracements are NOT Foolproof