Trying to time the breakout of every support and resistance level or chart pattern can be frustrating at times while trading. There are many other trading techniques available, but in this article, I’ll show you how to use the Fibonacci retracement, one powerful tool, and how to include it in your trading approach.
What is Fibonacci retracement?
The Fibonacci retracement is derived from the Fibonacci sequence, which occurs in nature and mathematics, introduced by an Italian mathematician. They are used in the financial market by traders when analyzing a price chart to determine potential retracement points.
It’s known as a set of unique levels that are displayed as horizontal lines to indicate the possible support and resistance levels where the price could potentially reverse direction.
Fibonacci retracement levels are also considered a predictive technical indicator since they attempt to identify where prices may be in the future.
How Fibonacci retracement works
In trading, these ratios are also known as retracement levels. Traders wait for prices to approach these Fibonacci levels and act according to their strategy. Usually, they look for a reversal signal on these widely watched retracement levels before opening their positions. The most commonly used of the three levels is 0.618 – the inverse of the golden ratio (1.618), denoted in mathematics by the Greek letter φ. Joo
What are Fibonacci retracement levels?
Fibonacci retracement is based on the sequence of hidden levels within the horizontal lines of support and resistance at which crypto prices have a chance of turning around. The primary tiers consist of 23.6%, 38.2%, 61.8%, and 78.6% respectively.
An Italian mathematician named Fibonacci developed a sequence that can be found in both nature and mathematics and named after himself. The Fibonacci retracement is based on this sequence. When traders in the financial industry examine a price chart to look for potential turning moments, they make use of these indicators.
How to plot Fibonacci retracement on the charts.
Plotting Fibonacci to the chart is very simple but can be confusing sometimes.
Fibonacci retracements are plotted from recent swing highs/ swing lows.
Before you draw a Fibonacci you have to determine what type of trend the market is.
There are basically two types of trends, which are
- Uptrend
- Downtrend
uptrend
In an uptrend whereby price creates Higher highs and higher lows (HH&HL) Draw your Fibonacci from the most recent HL to its present HH
Illustration diagram on how to plot a Fibonacci retracement in an uptrend
Downtrend
Then in a downtrend whereby price creates Lower highs and Lower lows (LH&LL) Draw your Fibonacci from the most recent LH to its present LL
An illustration diagram for how to draw a Fibonacci retracement for a downtrend.
Fibonacci retracement levels are used to enter a trade.
When using the Fibonacci retracement tool, there are certain Fibonacci levels to be considered as areas of retracement.
Each Fibonacci level indicates something about a trend.
Whenever you draw your Fibonacci and the price of the asset is in between any of the levels below
- 0.236:- Very strong uptrend/downtrend
- 0.382:- Strong uptrend/downtrend
- 0.5:- Stable
- 0.618:- Weak uptrend/downtrend
- 0.786:- very weak uptrend/downtrend
- 1:- change of trend
Using these retracement levels means you should enter a trade at 0.618 or 0.786, where the price is at its weakest, and then wait for a reversal to continue in the trend.
Then set your stop loss at 1 because when the price breaks below or above the 1 retracement level, it means there’s about to be a change in market structure.
Example of how to use a Fibonacci to enter a trade
Here’s a trade I entered on GMT/USDT in an uptrend
Here are the steps I followed to ensure I entered this trade with my Fibonacci
Step 1:-Determine the market trend, uptrend, or downtrend.
Gmt was clearly on an uptrend, so I plotted my Fibonacci from the recent swing.
Step 2:-set your entry at 0.786 and your stop loss at 1.
This way, the market would retrace back to the 0.786 level, thereby weakening the power of the bull in the swing.
Then I set my stop loss a little bit below 1. Level that way before you get kicked out of the trade. because there could be a shift in the trend
You can use the same steps for a downtrend and you’ll still get the same results.
Confirming Fibonacci with other indicators
However, the Fibonacci retracement is useful even when used by itself as a technique. Nevertheless, traders frequently make use of additional indicators in order to boost the quality of the signals they provide.
The tool for extending Fibonacci numbers is a natural addition to retracement analysis. Using the tool, one can get a better idea of how far the current trend may go in the future.
When working with Fibonacci levels, candlestick patterns and trend lines might be helpful. If the price of an asset is getting close to a retracement level, you should look for a candlestick pattern to confirm a resumption of the new bull trend. One example of such a pattern is the bullish engulfing pattern.
In conclusion, the Elliott Wave Theory makes extensive use of the Fibonacci retracement formula. Elliott Wave is a method for analyzing the market that is based on studying the market’s shape.
Conclusion
One of the most effective tools that traders have at their disposal is the Fibonacci retracement tool. It can assist you in locating previously unseen levels of support and resistance, allowing you to time your trades more effectively. However, there are several limitations to the tool. The utility provided by this tool is less useful for cryptocurrencies that have a lower market capitalization. On top of that, it might be hard to figure out which of the available levels is the best.
