Written by Robert McKinley

Fibonacci Retracements

Many different Fibonacci Forex systems or studies have been developed. Here, we will concentrate on Fibonacci Retracements because they are so important to Forex trading.

• Fibonacci Retracements are percentage values derived from the ratios and are widely used to help traders predict the length of corrections (retracements) in a trending market.
• The most often used retracement levels are 38.2% (notice the “382”?), 50%, and 61.8% (notice the “618”?).
• If a trend is strong, it is likely that the price will retrace at least 38.2%.
• In a weaker trend, the retracement may reach as far as 61.8%.
• The 50% retracement level is watched more closely than any other and is an area commonly used to buy in an uptrend or to sell in a downtrend.
• If a correction moves past a retracement level, watch for it to go to the next level. For example, through 38.3% to 50%, etc.
• If the price retraces more than 61.8% of the previous move (based on closing), expect it to go back to the beginning of the trend.

Fibonacci retracements in an up trend

NOTE: You will see the terms “Swing High” and “Swing Low” used throughout this lesson. Here is what they are:

• A Swing High can be identified by a candlestick that has at least two lower highs on both sides of it.
• A Swing Low can be identified by a candlestick that has at least two higher lows on both sides of it.

Finding Retracement Levels

One way to find retracement levels is to click on a significant Swing Low and then drag the cursor to the most recent Swing High. This will accomplish two things for you:

• It will show you each retracement level.
• It will also show you the ratio and the corresponding price level. You can see an example of this in the next chart, below.

As a rule, in an up-trend, the idea is to buy (go long) after a retracement to a Fibonacci support level.

Below, are examples of the Forex market in an up-trend.

The first example is of an hourly chart where retracement levels have been plotted by using the method given above. The trader clicked on the 110.78 Swing Low on 07/12/05 and dragged the cursor to the 112.27 on 07/13/05. This generated retracement levels of 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618).

According to Fibonacci Retracement theory, the trader can expect that if the pair then retraces from the high, support will be found at one of the above Fibonacci Levels. The reasoning behind this is that traders will be going long (placing buy orders) at these levels as the market pulls back.

So what actually happened? Well, in this case, the market declined (pulled back) down through the 0.236 level and went even deeper on the next day through the 0.382 level. However, it never closed below that level and later on that second day, it started to move back up again. So, in this instance, if the trader had bought at level 0.382, he or she would have made a good short-term trade. Take a look:

Fibonacci Retracement In down-trends

Below, are examples of the Forex market in a downtrend. The first example is of an hourly chart with a 1.3278 Swing High and Swing Low at 1.3169, which happened about two hours later. You can see the retracement levels at: 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236).

Since we’re in a downtrend, this time, the trader can expect that if the pair then retraces from the high, resistance will be found at one of the Fibonacci Levels. The reasoning behind this is that traders will be going long (placing buy orders) at these levels as the market tries to rally.

So what actually happened this time? Well, low and behold, the market attempted to rally and managed to squeeze past the 0.500 level hitting a 1.3227 high and then closed below that number. Then, as you can see, it reversed and continued its move downward. If you had sold at the 0.382 level, you would have done quite well. Take a look:

Now let’s take a look at an example where things didn’t work out so well. Again, this is an hourly chart. It shows a Swing High at 1.7438 and a Swing Low at 1.7336. The retracement levels are at: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). From the chart, we can see that the market made some attempts to break through the 0.500 level but was unsuccessful. Take a look at the chart:

If you had wondered what would have happened if you had placed a sell order at the 0.500 level, the answer would be: nothing good. It would have been a losing trade. As it turned out, the Swing Low appears to be the end (bottom) of the downtrend and the market actually rallied and moved up to above the Swing High. Take a look:

Fibonacci Retracement Levels Are Not Infallible

Even though the market will usually find temporary support during an uptrend and temporary resistance during a downtrend, you should know that this is not a sure thing. Here are some important things to know:

• There is no perfect way to predict at which level, exactly, support will be found.
• The weakest support/resistance level often appears to be level 0.236.
• Support and resistance seems to be found fairly equally-often at the other levels.
• Because charts may indicate that the market usually retraces to only level 0.382, you cannot depend on it to do that every time and then reverse. It can and will certainly other levels and then reverse.
• There will be times when the whole Fibonacci thing will seem to be totally irrelevant.

The major point here is to learn and understand Fibonacci Retracement for use if and when it fits into your particular trading strategy or philosophy. It is a very valuable tool and is used widely by successful Forex traders.

Also, you will learn later about the best way to use things like Stop Orders, Reward-to-Risk Ratio, and Money Management to protect yourself from excessive loss. Remember, successful traders use a combination of things to stay on top of the market.

More things to consider

At times, more than one retracement level will develop close to the price action. Some, if not all, of these retracement levels may be a part of longer-term price movements that can be seen on greater time-frame charts such as daily or weekly charts. So it is always a good practice to monitor these charts and factor these “significant support or resistance areas” into your analysis. It is often the case that when a number of Fibonacci retracements develop from price moves of different lengths, they will increase in strength. In other words, the significance of a price area is directly proportional to the size of the price moves from which the retracement levels originate and the number of levels that coincide.

Seek other confirmation

It is always a good practice to seek confirmation of support and resistance levels using other technical analysis tools in order to better judge whether currency prices will reverse at any given level. For example, if you see a reversal candlestick pattern along with some other similar indication of an impending reversal, the greater is the possibility that a correction (reversal) will occur. (To review the use of other tools, see the lesson on Support and Resistance.)

Some final thoughts …

As a Forex trader, one very good reason, among many, for you to become proficient in and to use Fibonacci retracements, is that they are so widely used by other traders. This is significant because the very fact that so many traders are using them to identify possible buy or sell opportunities, to enter trades, or to place stop orders, sometimes cause support and resistance levels to become self-fulfilling.

All good Forex books and courses on currency trading provide detailed information that can help you become a more successful Forex trader with Fibonacci retracements. Of course, whether with trend lines, Fibonacci retracements, or any other trading tools, practice is the key to attaining ever higher levels of proficiency.

There are some who liken the Forex market (the largest financial market in the world) to a natural (as in nature) mechanism governed by the same laws that govern all of creation. They argue that this is why Fibonacci levels (ratios) work so well in Forex trading. Whether this idea is true or not should not deter any serious trader from learning about them and including them in his or her Forex tool chest.

The next lesson is Review of Fibonacci Retracements.