Fibonacci retracements levels are horizontal lines plotted on a chart using the corresponding tool that display possible support and resistance levels. The levels are based on the Fibonacci’s golden ratio, that is 1.618 and it can be used to describe proportions of everything in nature, from atoms to complex patterns in the universe like celestial bodies, therefore, many traders believe that these numbers also have relevance in financial markets.
The retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used. The indicator is useful because it can be drawn between two significant price points, such as a swing high and a swing low to pinpoint a possible entry on a pullback. In an uptrend you draw it from the swing low to the swing high, while in a downtrend from the swing high to the swing low. The tool will then display the levels between those two points.
The thing that makes Fibonacci quite effective is because lots of traders use them and so everyone expects others to act from Fibonacci levels making it almost a self-fulfilling prophecy. Many traders also draw more Fibonacci levels from different swings when they are confusing to get confluence.
Look for the most obvious swings when drawing Fibonacci levels and try to get some confluence with other technical concepts like support and resistance, trendlines, indicators and so on. Fibonacci helps you to plot levels where a retracement from the overall trend may bounce back giving you a trading opportunity to enter or re-enter the market.
This article was written by Giuseppe Dellamotta.