Determine Market Turning Points In Advance With Fibonacci!
Fibonacci Retracements can be used to find levels of potential support and resistance where prices can reverse. On this page, we will look at what Fibonacci Retracements are and how we can use them to trade.
If you want additional training to master the skills of trading with Fibonacci, check out the Fibonacci Trading Resources section at the bottom of this page.
The Fibonacci Sequence
What are Fibonacci Retracements and how did they come about anyway?
Fibonacci Retracement levels are calculated based on the Fibonacci Sequence. And this sequence and its implications was discovered by Leonardo Fibonacci. No prizes for guessing why it’s called Fibonacci Retracements!
This indicator uses the mathematical ratios discovered by Leonardo Fibonacci based on the constant relationship between a sequence of numbers. This sequence of numbers is called the Fibonacci Summation Series.
1, 1, 2, 3, 5, 8, 13….
When adding two consecutive numbers, you will get the next.
1 + 1 = 2,
1 + 2 = 3,
2 + 3 = 5,
5 + 3 = 8, and so on to infinity.
What’s interesting about these numbers is the constant relationship between them.
- The sum of any two consecutive numbers equals the next higher number
- The ratio between any number and the next higher number approaches 0.618 after the first four calculations
- The ratio between any number and the next lower number is approximately 1.618 (the inverse of 0.618)
This number, 1.618, is commonly referred to as the Golden Mean. This ratio has been discovered in many natural phenomenons in terms of proportions from the Egyptian pyramids to the logarithmic spiral of the nautilus shell.
More importantly to us, however, is its application to trading!
Applying Fibonacci Ratios to Trading
All that history and background is great, but where it comes in really useful is when we apply it in trading. From these ratios, we get the common Fibonacci Retracement levels to find potential levels of support and resistance which we can then use in our trading!
In any trend, prices will move in a zig-zag pattern establishing highs and lows. Here is where we use Fibonacci Retracements to find where prices could make those highs and lows!
Prices often pullback or retrace a certain percentage of the previous move, before continuing in their original trend again. These percentages often correlate to these three main Fibonacci Retracement Levels - 38.2%, 50%, and 61.8%.
OK, the 50% level doesn’t really have anything to do with Fibonacci Ratios, but it’s also a level where prices tend to retrace to, so I believe they made it easier by putting 50% into the Fibonacci Retracement tool. 
Here’s a picture to show you what these 3 main levels look like:
The picture shows what Fibonacci Retracements look like in an uptrend. In a downtrend, just reverse the picture!
As prices move up in a trend they reach a high point (#1) and can retrace to certain percentage of the move (#2), before reversing and moving back in the original trend to new highs (#3). As a trader, you can watch for prices to pullback to these levels before initiating a trade in the direction of the original trend (either up or down).
Initiating A Trade
When you first identify a trend, you will wait for prices to start pulling back to form either a high or low. When you see that high or low form, you then pull out your Fibonacci Retracement tool to identify potential levels where prices can find support (or resistance). However, you do not just initiate a position at any of the common levels!
Before initiating any trade using Fibonacci Retracements, you first have to identify any chart patterns or trading signals forming around those levels! If you don’t see any trading signals forming at the first (38.2%) level, then wait. Prices may retrace further to the 50% level. The same applies at the 50% level, because prices could retrace further to the 61.8% level.
These Fibonacci Retracements mark potential support or resistance levels. Until they are confirmed by a trading signal of some kind, these levels are just potential reversal points.
Drawing Fibonacci Retracement Levels
How do you draw Fibonacci Retracement Levels?
In order to draw Fibonacci Retracements, we use swing points in a trend for the start and end points. Here’s an example:
While the example above illustrates an uptrend, you just reverse the swing points for a downtrend.
Most of the available charting platforms today have the Fibonacci Retracement tool available already. But if you want to calculate it by hand, you can use the following steps:
- Calculate the range between the Swing High and Swing Low.
- Multiply the range by a Fibonacci Ratio (38.2, 50.0, or 61.8).
- Take the Swing High (uptrend) or Swing Low (downtrend) less (or add) that result, and you get your Fibonacci Retracement Levels!
Tips On Fibonacci Retracements
How useful are Fibonacci Retracements for identifying support and resistance?
Fibonacci Retracements are just another tool in your trading toolbox. Sometimes they work beautifully, other times they don’t. However, you can increase your chances of success using Fibonacci Retracements when you combine them with clear and specific trading signals.
Using Fibonacci Retracement Levels on their own can lead to a lot of losses, because while they help to identify potential support and resistance levels, you won’t know if they’ll hold until prices start to reverse.
Prices can also sometimes touch these Fib levels exactly, and at other times they overshoot by a bit. The market isn’t a “perfect” mechanism, which can frustrate a lot of traders looking for the Holy Grail of trading. When you understand this, it helps you a lot in becoming a better trader by focusing not just on your entries, but on your trade and risk management as well!
As for Fibonacci Retracements, remember in trading the most important thing is price. Only when price tells you that a reversal is taking place, that’s when you initiate a trade and not before!
Fibonacci Trading Resources
For further in-depth lessons on Fibonacci Trading, you can check out the following courses:
- Fibonacci Trading by Neal Hughes (a.k.a. “FibMaster”)
A Trading System based around Fibonacci Retracements and Expansions, designed for Stocks, Options, Futures, and Forex traders. Because Fibonacci Ratios are found in all the financial markets, learning to trade Fibonacci allows you to trade practically every market available.
Master Fibonacci Trading to determine probable turning points in advance of the market, and be prepared to take advantage of your new knowledge and trading skill.