Fibonacci Retracement Guide: How to Use It

What is Fibonacci Retracement? 

A well-known technical analysis tool that many traders use to navigate the erratic markets, Fibonacci Retracement is used to study future potential support and resistance levels based on previous price movement.

The concept of Fibonacci was discovered by Leonardo Fibonacci in 1202 and his mathematical discoveries continues to shape and influence the modern world in various ways. His first discovery was the “Fibonacci Sequence”, referring to a specific mathematical sequence of numbers but what intrigued Leonardo was the ratio among the numbers, more specifically, the ratio 1.618. Dubbed as “The Golden Ratio”, this number exist not only in between the Fibonacci sequence but in the financial markets as well^[1].

Fibonacci Trading: How to Trade Using Fibonacci Retracement 

Apart from the famous Fibonacci Retracement, there are many other tools that serve as extensions such as Trend-based Fibonacci Extension, Fibonacci Channel, Fibonacci Time Zone etc.

However, the primary focus would be on the retracement. The application of the Fibonacci Retracement can be applied to many financial instruments on CFDs including the foreign exchange market, stock market, and even the Cryptocurrency market.

Within the financial markets, by taking two extreme points on a swing trend, the tool divides the area in between, which serves as area of interest for traders to consider a trade. Furthermore, it also provides insight to possible levels of take profit or levels where markets may reverse.

Table 1 – Fibonacci Retracement Levels & Usage [2] [3] 

Fibonacci Retracement Strategy 

Just through the Fibonacci Retracement tool alone, a trader can determine four key points; determining the trend (0% & 100%), areas of entry (23.6% to 78.6%), multiple areas to secure profits (-27% & -68%), areas that market would reverse if the main bias does not hold (127.2% & 161.8%)^[4].

This essentially enforces structure in every trade, which in turn can help to eliminate human errors.

How to Use Fibonacci Retracement 

Through the various case studies discussed below, it will highlight the proper usage of the Fibonacci retracement tool from planning to execution, and to exit strategy. The case studies will touch on both buy and sell examples on different CFDs on currency pairs to show the versatility of this tool. 

The examples below are used for educational purposes only. Past performance is not an indication of future results and any reliance on such is at your own risk.

Case Study 1 – Fibonacci Retracement Buy Application 

Case study 1 shows a buy trade on XAUUSD using the Fibonacci retracement tool.

Assuming a bullish bias, figure 1 shows an identification of a swing low to swing high on gold using the Fibonacci Retracement tool as indicated by the purple boxes.

In figure 2, gold markets retraced to 78.6% Fibonacci Retracement level which signifies a possible buy trade idea. A general rule of thumb is placing the stop loss one Fibonacci level below the entry, in this case, below the 100% level. The take profit level used would be the -68% level, giving this trade a potential risk to reward ratio of 1:5.8.

Figure 3 shows the gold trade hitting take profit targets 1 and 2, further highlighting how the tool structures a trade from start to end.

Case Study 2 – Fibonacci Retracement Sell Application 

Case study 2 shows a sell trade on AUDUSD using the Fibonacci retracement tool. 

Assuming a bearish market, figure 4 shows AUDUSD with the application of the Fibonacci retracement from a high to a low, indicated by the purple boxes.

In figure 5, AUDUSD can be seen retracing into the 61.8% level, giving rise to a possible sell trade idea with stop loss one level above the entry (78.6%) and take profit level at -27%. The potential risk to reward for this trade would be 1:5.2.

A completed AUDUSD sell idea in figure 6 with markets hitting Take profit 1 level, emphasizing the trade scaffolding that the Fibonacci Retracement has to offer.

Case Study 3 – Fibonacci Retracement Reversal Levels

At times when the trader’s bias is wrong (bullish bias but bearish market), reversal levels serve to help the adaptive individual to changing market conditions. Case study 3 shows the effective use of Fibonacci’s reversal levels on GBPUSD, switching from a buy to a sell bias. 

Note in figure 7, the Fibonacci Retracement is applied with the intent of a GBPUSD buy trade idea, from a swing low to a swing high.

In figure 8, the retracement levels do not seem to hold any weight and GBPUSD markets have broken below the 100% level.

Figure 9 showcases an adaptive sell trade idea below the 100% level when the areas of entries do not hold weight, targeting reversal levels 1 & 2, generating a risk to reward ratio of 1:2.3.

Where to find Fibonacci Retracement in MetaTrader 4/5 (MT4/5) & TradingView

The Fibonacci Retracement tool is not limited to just the mentioned platforms. However, here’s how you can find the Fibonacci Retracement tool on the following platforms.