Fibonacci retracements are ratios that allow traders to identify potential reversal levels. Here we’ll look at these retracements in a bit more detail.
The Fibonacci ratios commonly used are 100%, 61.8%, 50%, 38.2%, 23.6% - these are shown as horizontal lines on a chart and may identify areas of support and resistance. These levels are created by drawing a trend line between two extreme points and diving the vertical distance by the key Fibonacci ratios. These extreme levels are known as the recent swing high and swing low,
To identify the Fibonacci levels for an uptrend, click on the swing low and draw the trend line to the swing high. In a down trend you simply reverse the trend line. The following chart shows the Fibonacci levels on price which is in an uptrend.
As you can see on the chart, we have plotted the Fibonacci levels by clicking on the swing lows at 1.000 and swing highs at 1.14. The Fibonacci levels plotted show where price travels to and reverses, and are evident at the 61.8%, 38.2% and 23.6% levels. The 61.8% level is a common support level, as in the above example you can see the price has tested this level on many occasions. More recently, you can see where the price broke through the 38.2% level and retested this level. In this example there’s an expectation for the currency pair to test the 23.6% level at 1.11.
The next chart shows the Fibonacci ratios plotted for the pricing action in a down trend. As you can see, we’ve drawn a trend line from the swing high at 1.1037 to the swing low at 1.0994. Again, you can clearly see where the price reversed at key Fibonacci levels such as the 50% and 23.6% levels.
Fibonacci levels are by no means fool proof – they’re not areas where you would buy and sell from. You should look at them as areas of interest – an indication of where the price may go to in the future.
Combining Fibonacci ratios with support and resistance
Fibonacci ratios can be subjective, but can also be used to identify key support and resistance levels. A potential way to use the Fibonacci levels is to spot potential support and resistance levels, and see if these levels line up with the Fibonacci levels. If you do spot these levels, the chances of the price bouncing off them are higher.
As you can see from the chart, the key Fibonacci levels 61.8% and 38.2% have been areas of support and resistance previously, and by identifying this on the chart, these levels can potentially be areas where you could enter the market. With traders looking at the same support and resistance levels, there’s a good chance that there will be a number of orders around those levels.
Losses can exceed deposits.