As traders we have a vast arsenal of technical tools at our disposal and one that I regularly use is Fibonacci Retracement (Fib). Fibonacci was a famous Italian mathematician from the middle ages who is responsible for the Fibonacci sequence numbers.
The Fib numbers are, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and continues. The interesting part is when you start adding the first two numbers which then equals the third. Then followed by adding the 2nd and 3rd number which equals the 4th etc.
In Technical Analysis we use Fibonacci Retracement (Fib) in different ways when looking at the price action of an instrument on a chart.
In an Uptrend - The levels are plotted when looking at a charts recent swing low and swing high in an uptrend and connecting these reference points. Draw the line from Bottom (swing Low) to Top (swing high) and make sure you draw the line correctly.
When using the lower body of the candle as your starting point, make sure your end is the upper body of the candle. In other words, do not mix the reference points.
The chart below shows an uptrend and the Fib line drawn from recent swing low to the swing high in the AUDUSD currency pair. We can see that the 23.6% Fibonacci retracement line acted as support a couple of times but did not hold. Price is moving lower to the 38.2% Fibonacci retracement line which might act as support or target line depending on your strategy.
Source – MetaTrader5
Looking at the chart below we can see possible Fibonacci Retracement levels in an uptrend.
Source – ScientificPapers.org
The price action did in fact move to the 38.2% retracement line which could have served as your target point in a short trade from the 23.6% Fibonacci Retracement line. Price action retraced even further but found support at the midpoint line (50% Fib).
Source – MetaTrader5
In a Downtrend – the inverse would apply to the uptrend; the levels are plotted when looking at the Wall Street 30 charts recent swing high and swing low in a downtrend and connecting these points. Draw the line from the high (swing high) to bottom (swing low).
On the Daily chart of Wall Street 30 below we can see that the 78.6% Fib level is currently acting as resistance, so in other words the price has retraced 78.6% from the swing low back to the swing high. This might indicate that the price action might just move higher from this level if it manages to push through. Alternatively, the resistance will hold, and the price action will retreat lower with the 61.8 Fib level as target point.
Source – MetaTrader5
The chart below shows possible Fibonacci Retracement levels in a downtrend.
Source – ScientificPapers.org
The resistance at the 78.6% Fibonacci level did not hold and the price action pushed higher on the Wall Street 30. Looking ahead the 78.6% Fib level will be the new support level to watch moving forward with a target point between current level and the 100% Fib Retracement level.
Source – MetaTrader5
Summary:
Thinking of adding Fibonacci Retracement to your trading plan? Or as part of your strategy? Here are a couple things to consider:
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