Fibonacci Retracements: How To Use Them On A Chart Regarding the Fibonacci Indicator and its relation to price, the main rule is this:
When a correction starts in a trend, the price could end up moving to a maximum of 61.8% of the previous movement of the trend underway, or alternatively it could mean that it is not actually a correction but in fact another trend moving in the opposite direction to the one being analysed.
The numbers resulting from the golden ratio that interest us are: 61.8 – 38.2 – 50 – 23.6
We can exclude the last number as it is of lesser importance in my opinion and convert the others into percentages: 38.2% – 50% – 61.8%.
These are the famous Fibonacci Retracements and the technical indicator is based precisely on these numbers.
The Rule of Fibonacci Retracements
What follows is the most important rule to apply when thinking about using the retracements on your chart, so be sure to remember it well!
When a correction begins to form in a trend, it is highly likely that the price, retracing a reverse movement, will find supports, or resistances, near the levels identified as retracements, calculated from the beginning of the trend.
How To Use Fibonacci Retracements
To use the Fibonacci Indicator in technical analysis you will need to do the following:
UPWARD TREND: The point from which to start calculating the Fibonacci Retracements is the first minimum of the trend, then for the second point we choose the last maximum reached before the start of the downward correction.
This is because the Fibonacci percentages must be calculated on 100% of the movement.
DOWNWARD TREND: The point from which to start calculating the Fibonacci Retracements is the first maximum of the trend, then for the second point we choose the last minimum before the start of the upward correction.
See below for an example of how to chart the Fibonacci Retracements on an upward trend in which a downward correction has commenced.
The RED arrow going from the bottom upwards indicates the point from which to commence the calculation of the Fibonacci Indicator (shown at bottom left) and the point where it should end (shown at the top).
The calculation shown is done automatically by the Fibonacci Retracement technical indicator available on the trading platform.
Once the Retracement has been charted in relation to the trend that interests us we can search within the retracement zones for prices that could reach a support or resistance. In this particular case we are looking for support zones, as we can see the commencement of a downward trend.
You can see particularly within the Fibonacci zones of 50% and 61.8% / 76.40% of the trend in question, that the price has effectively found a support.
At the 50% Fibonacci level the price has bounced slightly for 2 candles (Green arrow), at the 61.8% retracement level instead, it seems that the correction has stopped, indicating with a high probability that the major trend will remain intact at least for the time being.
We will have confirmation that the major trend will recover only when the price reaches other maximums that are higher than the last maximum shown above, which is the maximum from where the downward correction began.
If instead, we need to confirm the trend retraction, the price must exceed and stabilize above the 61.8% Fibonacci Retracement level. The rule explains that over that level, the price will no longer be a trend correction, but in fact will be a new trend in the opposite direction.
Let’s move on to a technical analysis chart with a downward trend and discover how to plot the Fibonacci levels.
Fibonacci For A Downward Trend
As you can see, the primary trend is bearish. Starting from the absolute maximum (the point at top left), we can plot the Fibonacci Retracements with the indicator touching the lowest minimum of the trend.
You can see here, I have indicated with a blue arrow that it starts from the maximum and goes down to the minimum. This is the trend taken into consideration to find the Fibonacci levels.
We can quickly see that the Fibonacci level around of 38.2% proved to be a decent resistance and in fact the price went to touch this level and then stopped with great precision (Green sign) on the chart).
The ascent stopped but recommenced later thereafter, breaking through a resistance level and continuing to rise in search of the next resistance.
If the price were to exceed this level and be confirmed, we would be facing a retraction of the main bearish trend, therefore certain levels must absolutely be kept under observation.