A beginner's guide to trading with Fibonacci Retracement
By Paul Reid
11 September 2023
The Fibonacci retracement tool may sound complex, but it's actually quite easy to use once you grasp the basics. Let’s walk through the key concepts and steps to effectively use the Fibonacci retracement trading tool in concert with your trading strategy.
The origins of the Fibonacci Retracement tool
Fibonacci retracement is named after Leonardo Fibonacci, a mathematician who discovered the series of numbers with unique mathematical properties, named after him as the Fibonacci sequence.
The Fibonacci numbers advance by adding the sum of the two preceding ones. It starts with 0 then 1 and continues like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. This ratio appears in nature, architecture, galaxies, and even the human body. It also shows up in trading. The key number generated from this sequence is the "Fibonacci golden ratio," approximately 1.618.
1.618 is inverted to create 0.618 or 61.8%. From there, additional levels are generated including 23.6%, 38.2%, 50%, and 78.6%. These are the retracement levels that signal a possible rebound. Technical traders work on the assumption that if a retracement or price fallback reaches one of these levels, there is a strong likelihood that the trend will resume its original direction from that point.
Using Fibonacci Retracement
The best way to learn is to practice, so open up a chart on the Exness Trading Terminal. To lay the Fibonacci retracement graph over the chart, go to the tooltip bar directly to the left of the chart. You’ll see a 4-line icon second down from the crosshair.
For a recent price high that’s currently bearish, start drawing the Fibonacci Retracement at the most recent low, holding the click until the pointer is on the latest high. Colorful lines will stretch out on the chart showing the retracement levels.
If the price is currently bearish, start drawing the Fibonacci Retracement at the most recent high, holding the click until the pointer is on the latest low. Now the levels are showing on the chart, it’s time to analyze the chart and start forecasting.
Identifying a price retrace using the Fibonacci retracement levels
Start by identifying a clear price trend on your trading chart. It can be an uptrend (prices going up) or a downtrend (prices going down).
If an asset is in an uptrend and starts to pull back, apply Fibonacci retracement. If the current price retraces to the 38.2% level and then continues the uptrend, it indicates strong support at that level.
For a downtrend, if the price retraces to the 61.8% level and then reverses, it suggests strong resistance at that level, making it a potential entry point for a short trade. Watch for price actions that reach these levels.
Best practices for the Fibonacci retracement
Now you know how to set the Fibonacci retracement levels on the charts, but which assets and which timeframes are ideal for this forecasting tool?
Fibonacci retracement levels can be applied to any asset class. Rebounds at the retracement levels have been observed throughout the entire financial world. As for timeframes, the Fibonacci retracement is considered to be most accurate on longer timeframes such as daily or weekly charts. Shorter timeframes may have less reliable retracement levels, so day traders may choose not to use the Fibonacci retracement tool when forecasting.
To improve the reliability of your results, consider combining the Fibonacci retracement tool with other technical indicators to confirm your trading observations before committing to a trade.
In addition, have a risk management strategy in place. Never commit your entire equity to one trade, as market volatility may wipe out your account. Consider setting stop-loss to limit potential losses.
Fibonacci Retracement and other powerful tools and indicators help eliminate the guesswork from a trader’s forecasting and analysis and focus more on mathematical reasoning. Fibonacci Retracement remains a very popular method that many traders use and recommend, but, as the disclaimer goes, past performance does not guarantee future results.
There will always be outliers and unexpected price actions, often related to fundamental influences. It is strongly recommended that you use other indicators alongside the Fibonacci Retracement tool. Moreover, data reports, economic uncertainty, and political turmoil can also disturb market patterns, so don’t rely on technical analysis alone when forecasting.
This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.
Paul Reid is a financial journalist dedicated to uncovering hidden fundamental connections that can give traders an advantage. Focusing primarily on the stock market, Paul's instincts for identifying major company shifts is well established from following the financial markets for over a decade.
Back to all articles