Fibonacci Retracement

Fibonacci Retracement Explanation

In forex trading, Fibonacci retracement is a technical analysis tool used to identify potential levels of support and resistance by drawing horizontal lines at key Fibonacci levels. These levels are derived from the Fibonacci sequence, a series of numbers where each number is the sum of the two preceding ones. Traders use these levels to predict possible reversal points in the price of a currency pair after a strong price movement.

The most common Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 100%. These levels represent the percentage of a price movement that may be retraced before the price continues in the original direction. Fibonacci retracements are widely used because they are believed to reflect natural market psychology and patterns.

Fibonacci Retracement History

The Fibonacci sequence was introduced by Leonardo of Pisa (also known as Fibonacci) in his book Liber Abaci published in 1202, though the sequence had been used in earlier times in various cultures. The use of Fibonacci levels in technical analysis emerged much later, gaining popularity in the 20th century among traders like Ralph Nelson Elliott, who incorporated Fibonacci ratios into his Elliott Wave Theory.

Fibonacci Retracement Etymology

The term Fibonacci comes from the name of the Italian mathematician Leonardo Fibonacci, who introduced the sequence of numbers that forms the basis for Fibonacci retracement levels. The word “retracement” refers to the concept of price retracing a portion of its previous movement before continuing in the original direction.

How does Fibonacci retracement work?

Fibonacci retracement works by identifying key levels in the price movement where a currency pair is likely to experience a pullback (or retracement) before resuming its trend. Traders draw Fibonacci levels from the low to the high of a price move (for an uptrend) or from the high to the low (for a downtrend). The levels indicate where the price could potentially reverse, and traders watch for price action at these levels to enter or exit trades.

What is a good Fibonacci retracement?

A good Fibonacci retracement level is one where price shows signs of reversing, such as forming candlestick patterns or showing increased buying or selling volume. Traders often focus on the 38.2%, 50%, and 61.8% levels as the most significant, as these are the levels that often see a strong price reaction. However, the “best” level can vary depending on the market context and other technical indicators.

What are the 7 Fibonacci levels?

The most commonly used Fibonacci retracement levels are:

23.6%
38.2%
50%
61.8%
76.4%
100%
161.8% (not always considered a retracement level but often used as an extension level for predicting price targets)

These levels help traders identify where the price may pull back before continuing in the trend direction.

How to draw Fibonacci retracement correctly?

To draw a Fibonacci retracement correctly, follow these steps:

Identify the trend: Find the most recent significant price move (either an uptrend or a downtrend).
Select the swing points: For an uptrend, select the most recent low and high. For a downtrend, select the most recent high and low.
Draw the retracement levels: Using a Fibonacci tool on a chart, draw from the low to the high (for an uptrend) or from the high to the low (for a downtrend). The Fibonacci tool will automatically mark the retracement levels at key Fibonacci percentages.
Watch for price action: Observe how the price reacts to these levels, looking for signs of reversal such as candlestick patterns or volume spikes.