Most people who passed through the educational system know of the Italian Mathematician Fibonacci, but how many know that an indicator was named after Fibonacci? Fibonacci retracement lines are horizontal lines based on the Fibonacci numbers that predict where support and resistance would possibly occur. The retracement levels are 0%,23.6%, 38.2%, 50%, 61.8%, 78.6% and 100%. although 50% is used, it’s unofficial.
This indicator is very useful because it can be drawn between any two significant price points, such as a high and a low, and then create the retracement levels between those two points.
However, you should know that just because price action has reached your Fibonacci Retracement level it does not signify a perfect entry, awaiting confirmation from other combined indicators is the ideal way to go before entering a trade as the price could break and pass the retracement as easily as it can bounce from it.
Before moving on to the individual levels, let’s start with levels in general. A level itself is not a signal but a zone where a signal may form, which could be a point for you to monitor price action and once that signal is formed you can make at least two predictions from that: the direction prices are going and next price target level.
This is how Fibonacci works; once price has reached or come close to one of the Fibonacci levels it will form either a reversal or a continuation signal.
If it will be a reversal, bottoming or other signals develops so you can be sure that prices will reverse from that point, at least in the near to short term. If it’s a continuation signal or other sign of momentum or strength (either bullish or bearish depending on direction) forms, with confirmation from any other indicator, you can be sure that prices will continue in the direction they have been moving. In either case, the next target will probably be the next Fib level. In the case of a bounce, it will be the previous level, in the case of a break, it will be the next level past the break. As a rule of thumb, either type of entry signal can form on either side of the retracement level, which is why confirmations are so important.
Rules For Fibonacci Retracement Levels
Do you want to start but don’t know where or how?
First, you must choose a trading pair to study with the Fib tool. Fibonacci measures a retracement, or reversal, of price so the best place to use the tool is in a trending market. Start at the bottom of a rally or the top of a decline and draw the tool from the starting point to the next highest/lowest peak/trough. After that, it is time to start waiting and watching for a perfect entry signal. As stated above the 7 Fibonacci Retracement levels are 0%,23.6%, 38.2%, 50%, 61.8%, 78.6% and 100%. 0% is no retracement of the movement, 100% is a full retracement of the move.
The 23.6% Retracement
This is the first level. If prices retreat to this level and bounce, it is more likely for the underlying to trend than it is to reverse. If prices break this level, then the underlying trend may consolidate around that level or reverse course altogether but consolidation is more likely.
The 38.2% Retracement
This is the second level. If prices have broken the first level this is your next target. At this level, if prices bounce then it is more likely that a near to short-term consolidation is in play than a major reversal. Prices may hover here or bounce back to the 23.6% level. If prices break this level a deeper correction, but not necessarily a reversal, is in play.
The 50% Retracement
This is the third line and where things can really start to get interesting. As before, if prices break the 38.2% line, then the 50% retracement becomes your target. If prices bounce from this level there is a good chance that they will return to retest support at or near the previous low/high that the Fibonacci Retracement is based on, or the 0% line. If, however, prices break the 50% line then all of a sudden, a full 100% retracement becomes a possibility. A break of this line indicates an underlying strength/weakness in the market, depending on which direction the retracement is moving.
The 61.8% Retracement
This is the fourth level of retracement. If price breaks the 50% level this is the next target and may be reached very quickly as momentum traders get on board. Once prices reach here the underlying trend is broken and over. Prices may consolidate along with this level, move higher and retest the 50% level or continue on to the next level and possible full retracement.
The 78.6% Level
This is the fifth and final level, not counting the full 100% retracement. If prices break the 61.8% level this is your target, and like the previous level, prices may reach this level with a quickness. This level can often become support/resistance in a longer-term sense once prices reach it. A bounce from this level will usually mean a longer-term consolidation while a break of it will lead to the next target, the 100% retracement.