Introducing Fibonacci Retracements
If you have a requirement to predict the future directional movements of price, then you could use the Fibonacci Retracements to help you accomplish this task. The Fibonacci Retracements are an effective technical indicator that can be used in many different financial markets, such as currencies, binary options, commodities, futures and stocks, etc.
So, what are Fibonacci Retracements and how can you best use them? Leonardo Fibonacci discovered his revered theory back in the 12th century. The primary concept, as stated in terms of financial trading, predicts that price will reverse by a defined amount of its latest bullish or bearish trend before it recommences advancing in its original direction.
The key retracement percentages are 38.2%, 50.0% and 61.8%.
Leonardo identified these important ratios when he observed that a human’s belly button was positioned at exactly 61.8% of the distance between its head and feet. Similarly, you will find that your elbow rests at 61.8% of the length between your shoulder and hand. There are many more such examples in nature.
How can you use this feature to help you trade assets?
You can do so because Fibonacci retracements are always a central aspect of any price movements. For example, in the following diagram price has been descending within a well-defined bearish channel, as denoted by the red dotted line displayed towards the left of the chart. The Fibonacci retracements (the three blue horizontal lines) predict the most likely distances that price will retract before proceeding in its original direction.
To optimize the best use of this powerful indicator, you must first search the trading charts to locate those assets that have recently generated the largest price surges, either upwards or downwards, as possible. The above diagram represents a good example as it displays a well-developed bearish trend on the left.
Once achieved, you must next connect the highest and lowest values of this movement. Your trading platform will then produce the Fibonacci retracements automatically similar to the ones shown on the above diagram.
For instance, the three blue horizontal lines displayed above represent the retracement distances that are equal to 38.2%, 50% and 61.8% of the total length of the original bearish price movement.
For example, the 61.8% level identifies that point which price needs to hit in order to retract by 61.8% of the total length of the original bearish trend.
After price bounces against one of the Fibonacci retracements, you should then consider executing a new position in the original price direction if that level successfully holds.
For example, as price ricocheted against the 50% retracement level in the above chart, a sell position should have been activated at that point. Under such circumstances, a stop-loss should have been positioned on the other side of the next Fibonacci level which, in this case, is the 61.8%.
Retracements are a normal part of trading.
They occur all the time and a trader needs to know how to use retracements to his advantage. This is what the Fibonacci retracement tool does for you. The tool plots five horizontal lines on the charts which correspond to 5 possible areas to which prices may retrace, with the distances expressed in terms of percentage of the original move: – 100% – 61.8% – 50% – 38.2% – 0% Prices can retrace to any of these points.
So how would you use the retracement tool to trade
If I were to trade using retracement, this is what I would do
- I would select a strongly trending financial instrument, such as gold, EURJPY, GBPJPY or EURUSD.
- I would work only on a time frame that will confirm that what is playing out in the market is actually a retracement and not something else. I would therefore choose the Daily chart.
- I would pick a point between current prices and the 23.6% retracement point.
Note that by selecting the Daily chart for the EURUSD chart, I have already fulfilled my first two trade conditions.
It is a daily chart, showing me when a retracement is actually occurring, and the EURUSD trends well, being the most actively traded currency pair in the market. I am now looking for how to fulfil my third condition, which is actually my trade objective.
I want to pick a strike price at a point along the course of the price retracement, between the market price and the 23.6% Fibo level.
To do this successfully, I must be sure that a retracement is actually in progress.
How do I confirm this?
Look at the area where a red arrow points to “drag Fibo tool here” on the left side of the chart. The bullish momentum of the EURUSD has actually been checkmated by the formation of a reversal candlestick pattern, a bearish harami.
An expanded version of that point is shown below: Occurring at the peak of a bullish momentum is a clear reversal signal. The retracement followed soon after, and went all the way to the 50% retracement point.
Trading is not rocket science. It just takes a trader knowing what to do and when to do it. But it also requires that the trader must be quite knowledgeable about topics such as candlesticks, chart patterns, etc. A trader has to be thoroughly at home with the candlestick patterns. If there is any topic in the financial markets that deserves attention, this is it.
With candlesticks, you can determine price direction easily, and then add other tools to increase the success rate of your trade calls.