Technical Analysis – Fibonacci Retracement Levels
One of the most important trading tool, 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, and not only. The Elliott Waves theory is based on Fibonacci numbers. As a matter of 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 is to be found in any trading platform. The MetaTrader 4 platform is having a special tab dedicated to the Fibonacci tool.
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Under the Insert tab, look for the Fibonacci one, and on the right 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 to 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 be measured 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 no 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 is retracing 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 bigger time frames, like 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 powerful the golden ratio is.
The image above shows the EURUSD monthly chart and the Fibonacci retracement tool is 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 is no wonder that the market is hesitating at current levels for the last twenty-three candles (months). Traders are looking for a rejection at current levels and it is clear the market is hesitating here.
50% Retracement Level
The next retracement level, in the order of their importance, is the 50% one. While it is having 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 likely corrective waves are in place and a reaction at the 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 are rarely retracing more than 23.6% of the previous a-wave in the Elliott Waves theory. If on the other hand, is retracing more than 38.2%, chances are the market is not forming a zigzag after all. Therefore, 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. How to add these levels in the trading tool? The answer is easy. We need to edit the trading tool in such a way to see these levels on the screen as well. To do that, the Fibonacci trading tool must be selected and then right-click Fibo properties, and the levels can be edited. The image below shows you this process.
After selecting the Fibo properties, different levels can be added/deleted from the tool. Even the style/color of the tool can be changed to the desired one.
Here it should be mentioned that traders are missing one important point: everyone is focusing on the retracement levels up to complete retracement. However, there is not enough. Trading theories are calling for bigger 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 Wave 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 than the regular ones. Moreover, if the b-wave is retracing more than 161.8%, then the move to follow is not possible 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 and make the most of their powerful implications.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market.
- Basics of Fundamental Analysis
– What is fundamental analysis, where to look for information that makes the market moving, advantages and disadvantages of trading based on fundamentals.
- Trend Indicators
– Explaining what trading indicators are, where to find them, and their benefits when trading Forex market based on technical analysis.
– Discussing what oscillators are, what are the differences between an oscillator and a trend indicator, and what are the most representative indicators that fit into this category.
- Central Banks
– What is the role of a central bank in Forex trading, why the market is moving aggressively when monetary policy is set and what information to look for when the central bank is deciding over 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 are looking to buy into support and sell into resistance.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
Other Educational Materials
- “The applications of the Fibonacci sequence and Elliott wave theory in predicting the security price movements: a survey.” Chatterjee, Amitava, O. Felix Ayadi, and Balasundram Maniam. Journal of Commercial Banking and Finance 1 (2002): 65-76.
- A computational exploration of the efficacy of Fibonacci Sequences in technical analysis and trading. Bhattacharya, S. and Kumar, K., 2006.