If you have been trading for a while or you are a beginner, you must have heard of the Fibonacci retracement levels. Most traders who want to be consistent in winning trades rely on Fibonacci retracement tool and levels and other indicators to place and close trades.
Fibonacci retracement levels are parallel lines that help traders identify trading support and resistance levels. These levels are vital because they pinpoint areas where the price is likely to reverse. With this information, traders can choose to hold trades or close them with profits.
The main levels of Fibonacci retracement are 23.6%, 38.2%, 61.8%, and 78.6%. Therefore, as a trader, you should always be on the lookout when the price of your target trade reaches these levels. There is also a 50% retracement level that is not deemed or identified as a ratio. However, it is included in the Fibonacci retracement tool to mark or identify a 50% trend retracement. In most instances, price finds a way of always retracing or reacting to a support or resistance in this 50% level. With this in mind, the following is a breakdown of how to use the Fibonacci retracement tool when placing trades.
How to Use Fibonacci Retracement Tool
So how to use Fibonacci retracement tool? Fibonacci retracement levels rely on the theory that after price commences on a new trend, the price will partially retrace to a previous price level before returning back to its initial direction/trend. As such, Fibonacci retracement levels are appraised by traders to be predictive technical indicators since they help traders to identify where the price of a commodity or currency will trade in the future.
Fibonacci retracement levels work perfectly in trending markets. A trending market is a market that has been following a particular direction for days, weeks, or months. This trending market can either be an uptrend or a downtrend. The idea of using the Fibonacci retracement levels in an uptrend market is to buy when the price hits a Fibonacci support level and to sell when the price hits the resistance level in a downtrend.
In most instances, Fibonacci retracement levels are fulfilling because most traders place their trades in the identified support and resistance levels, thus moving the price to its designated direction. This can be based on the fact that if the majority of traders believe that a price retracement will occur close to a Fibonacci retracement level, these traders will place their trades in the respective levels. When the price reaches the level, the pending trades will be triggered, which can significantly impact the market price.
It is of the essence to note that price will not always bounce on an identified retracement level. If this were the case, every trader would be a successful trader. Therefore, it is vital to identify areas of interest and place your trades in these areas.
How to Find Fibonacci Retracement Levels
In order to find Fibonacci retracement levels, you must first find the recent Swing Lows and Swing Highs. These are significant levels where the price reached a new high or low. Once you have identified the Swing High level on a downtrend, the next step is to activate the Fibonacci retracement levels tool. The location of this tool differs from one trading platform to the next. Therefore, it is advisable to be well-versed with your trading platform.
Once you have identified a trend, its high, lows, and activated the Fibonacci retracement levels, the next step is to move your mouse cursor to the Swing High of a downtrend and drag your cursor to the previous Swing Low. In other words, you will be drawing the Fibonacci retracement level from left to right, stopping at the end of the identified downtrend. For an uptrend, you basically do the opposite. Click on the recent Swing Low and move your cursor to the previous Swing High.
After drawing the levels, the next step is to sit and watch as the price moves towards the key levels of the Fibonacci retracement tool. Always focus on these key levels and anticipate a reversal. When you have confirmed a reversal, enter the trade in the direction of the initial trend. For example, if you were expecting buys, wait for the price to retrace to a support level and once you identify a reversal, buy the trade. The good thing about relying on Fibonacci retracement levels is that they are static and do not change, unlike other indicators such as moving averages or RSI. This makes it easy for a trader to identify the levels and quickly decide whether or not to enter the trade.
Using Fibonacci Retracement Levels to Manage Risks
Good traders will always manage their trades by placing a stop loss. In an uptrend, always place your stop loss below the most recent swing low or below a Fibonacci retracement level that you used to enter a trade. For instance, if you enter a trade using a 61.8% retracement level, place your stop loss about 5 or 10 pips below the retracement level. In a downtrend, always place the stop loss above the most recent swing high. In a downtrend, manage your risk by applying the same principle as explained above. It is also advisable to use a risk-to-reward ratio where your target price is at least twice your stop loss.
Undoubtedly, the Fibonacci retracement tool is a powerful tool that can bring consistent profits when used accordingly. This is because it can help a trader identify support and resistance levels. However, like any other trading tool, the Fibonacci retracement tool is not foolproof. Therefore, it is advisable to use it in tandem with other indicators such as candlestick patterns, Relative Strength Index, and moving averages. For example, if a moving average is in the exact location as a Fibonacci retracement level, the price is likely to react to the level since there are two support or resistance obstacles.