How to Trade: Fibonacci Retracement (Advanced)
The first thing in our Forex Trading Floors 'How to Trade' blog that you should know about the Fibonacci tool is that it works best when the market is trending.
The idea is to go long (or buy) on a retracement at a Fibonacci support level when the market is trending up, and to go short (or sell) on a retracement at a Fibonacci resistance level when the market is trending down.
In order to find these retracement levels, you have to find the recent significant Swing Highs and Swings Lows. Then, for downtrends, click on the Swing High and drag the cursor to the most recent Swing Low.
For uptrends, do the opposite. Click on the Swing Low and drag the cursor to the most recent Swing High.
How to apply Fibonacci Retracements
This is a daily chat of AUD/USD:
The image above is an example of Fibonacci retracement levels plotted by clicking on the Swing Low at .6955 on April 20 and dragging the cursor to the Swing High at .8264 on June 3. The software will then show you the retracement levels.
As the chart shows, the retracement levels were - .7955 (23.6%), 7764 (38.2%), .7609 (50.0%), .7454 (61.8%), and .7263 (76.4%).
The expectation is that if AUD/USD retraces from recent high, it will find support at one of those Fibonacci levels because traders will be placing buy orders at these levels as price bulls back.
The next diagram demonstrates what happens after the Swing High occurred.
Price pulled back right though the 23.6% level and continued to shoot down over the next couple of weeks. It even tested the 38.2% level but was unable to close below it.
Later on, around July 14, the market resumed it's upwards move and eventually broke through the swing high. Therefore buying at the 38.2% Fibonacci level would have been a profitable long-term trade.
Below is an example of how the Fibonacci retracement tool used during a downtrend on a 4-hour EUR/USD chart.
The above images is an example of a Swing High at 1.4195 on January 26 and a Swing Low at 1.3854 a few days later on February 2nd. The retracement levels are 1.3933 (23.6%), 1.3983 (38.2%), 1.4064 (61.8%) and 1.4114 (76.4%(.
The expectation for a downtrend is that if price retraces from this low, it will encounter resistance at one of the Fibonacci levels because traders will be ready with sell orders there. The below image demonstrates what happened next.
The market did try to rally, stalled below the 38.2% level before testing the 50.0% level. If you had some orders either at the 38.2% or 50.0% levels, you would have made some mad pips on that trade.
In these two examples, the price found temporary support or resistance at Fibonacci retracement levels. Because of the people that use the Fibonacci tool, those levels become self-fulfilling support and resistance levels.
Fibonacci works better when the market is trending
Go long (buy) on retracement at a Fibonacci support level when the market is trending up
Go short (sell) on a retracement at a Fibonacci resistance level when the market is trending down
Note that the price will not always bounce from these levels. They should be looked at as areas of interest
Always practise on demo first as Fibonacci is not easy to use
Forex Trading Floors offers one-to-one coaching on Fibonacci levels, either online or at the trading floor. If you would like more information about our Trader Coach please email or call us on 01277 232223