Technical Analysis – Fibonacci Retracement Levels

One of the most important trading tools, if not the most important one, is the Fibonacci Retracement tool. Fibonacci numbers or sequences are used in the technical analysis in many trading theories. The Elliott Waves theory is based on Fibonacci numbers; in fact, the theory would not work if it wasn’t for the Fibonacci numbers. Just to give you an example, a flat or a zigzag pattern can be defined based on the Fibonacci retracement level the b-wave makes. The Fibonacci tool is handy in this case. Traders use the Fibonacci retracement levels as an individual tool as well. The way to go is to simply measure the length of a move and then check the resulting levels.

The Most Important Fibonacci Retracement Levels

The Fibonacci Retracement tool can be found on any trading platform. The MetaTrader 4 platform has a special tab dedicated to the Fibonacci tool.

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Under the Insert tab, select the Fibonacci option, and on the right-hand side, all the tools are listed. As you can see, the retracement tool is only one of the five Fibonacci tools offered, but it is the most important one. The Time Zones tool uses the Fibonacci sequence on time levels, while the other ones have different uses. Coming back to the retracement tool, after selecting it, traders need to click and drag from the start of the move to measure to the end of it.

The Golden Ratio

The golden ratio is the 61.8% retracement level. It has so many applications in the technical analysis field that it is not surprising it is called “the golden ratio”. In the Elliott Waves theory, for example, there is a strong belief that the second wave in an impulsive wave retraces 61.8% of the previous wave. Since the third wave to follow is supposed to be the longest and the fastest, everyone is looking to jump on it at the 61.8% retracement. On the longer timeframes, such as the monthly or weekly ones, simply the fact that market is reaching a 61.8% retracement level is a support and resistance, and traders will look to close their previous trades and open new ones. That is how powerful the golden ratio is!

The image above shows the EUR/USD monthly chart, with the Fibonacci retracement tool dragged from the previous lows to the end of the pattern. The pattern ends with a triangle as a reversal pattern, so the Fibonacci tool should be dragged from the end of the triangle/pattern. After deploying the Fibonacci tool on the screen, it becomes clear why the market has hesitated at current levels for the last 23 candles (months). Traders are looking for a rejection at current levels, and it is clear that the market is hesitating here.

50% Retracement Level

The next retracement level, in order of their importance, is the 50% one. While it has little use in trading strategies like the Elliott Waves theory, it is an important one for most traders. The fact that the market can retrace half of a move tells much about the general trend in place. Most probably corrective waves are in place, and a reaction at that level is expected.

Other Fibonacci Levels

Besides the 50% retracement level, 38.2% and 23.6% are useful as well. For example, strong zigzag patterns rarely retrace more than 23.6% of the previous a-wave in the Elliott Waves theory. If, on the other hand, retracement is more than 38.2%, the chances are that the market is not forming a zigzag after all. In this way, the Fibonacci levels are used for correct interpretation of a forecast. The levels mentioned so far are the classical ones everyone knows. However, there are retracement levels that are part of trading strategies other than the ones mentioned above. Such a level is the 80%. The Gartley trading method – the entire strategy – is based on the 80% retracement level. The 81% level is used in the Elliott Waves theory to make the distinction between different types of flat patterns. So how do we add these levels in the trading tool? The answer is easy. We need to edit the trading tool in such a way as to see these levels on the screen as well. To do that, the Fibonacci trading tool must be selected, and then right-clicking on Fibo properties allows the levels to be edited. The image below shows you this process.

After selecting Fibo properties, different levels can be added/deleted from the tool. Even the style/colour of the tool can be changed to the desired one.

Here it should be mentioned that traders are missing one important point: everyone focuses on the retracement levels up to complete retracement, but that is not enough. Trading theories call for higher retracement levels in specific patterns, such as 123.6%, 138.2%, or even 161.8%. To give you an example, a flat pattern under the Elliott Waves principle can have a b-wave retracing more than the 100% level. This means that the flat is one with a strong b-wave, and the types of flats that fall into this category are different from the regular ones. Moreover, if the b-wave retraces more than 161.8%, then it is not possible for the move to follow  to completely retrace the b-wave. As you can see from this article, there are multiple uses for the Fibonacci numbers in the technical analysis field. The only thing is to know how to interpret them to make the most of their powerful implications.

• Forex Trading – Explaining the Concept
• Basics of Fundamental Analysis
– What fundamental analysis is; where to look for information that makes the market move; and advantages and disadvantages of trading based on fundamentals.
• Trend Indicators
– Explaining what trading indicators are; where to find them; and their benefits when trading the Forex market based on technical analysis.
• Oscillators
– Discussing what oscillators are; the differences between an oscillator and a trend indicator; and the most representative indicators that fit into this category.
• Central Banks
– The role of a central bank in Forex trading; why the market moves aggressively when monetary policy is set; and what information to look for when the central bank decides on its policy.
• Technical Analysis – Support and Resistance Areas
– Defining what support and resistance areas are; how to find them using technical analysis; and why traders look to buy into support and sell into resistance.
• Forex Brokers Types – ECN or STP?
– What ECN and STP are; how brokers deal with clients’ orders; and advantages and disadvantages of the two types.

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