A market rarely moves vertically up or down, prices tend to retrace a predictable part of a move, known as Fibonacci retracements, then continue along its trajectory either up or down.
Fibonacci retracements attempt to make a science out of the “random walk” the ordinary price volatility of the market to determine support and resistance levels.
So Fibonacci retracements are defined as short term price corrections during an overall larger trend, in either an upward or downward trend.
What are the benefits of using Fibonacci retracements?
Fibonacci retracements indicate price corrections and temporary price reversals, but they don’t indicate a change in the direction of a larger long term trend.
So the main benefits of Fibonacci retracements is that they can help you trade at a better price just before the continuation of the move
Why do Fibonacci retracements occur?
Let’s look at an upward trend when a significant number of traders want to buy as they believe that the market price will increase, this pushes the market higher and as more traders notice the movement they start buying as well. When the movement has gained traction some traders will close their position to take profit, this results in a temporary sell-off as some traders take profits and the upward moment is temporarily suspended. After this the original force which causes the upward trend continues and so too does the upward price trend until it too runs its course.
How do you enter trades using Fibonacci retracements?
First find a strong upward or downward movement of a given financial instrument.
In an upward trend, a bull market, the Fibonacci retracements price pullbacks are viewed as buy support levels. Likewise, in a downtrend, the Fibonacci retracements are useful in technical analysis for selling rallies in a downtrend.
Fibonacci retracements, in an upward market, are used to help determine when the market will pull back. To identify Fibonacci retracements levels in your chart you need to identify swing high and swing low levels in your chart. A swing high is the highest point of a given period. A swing low is lower than any other point over a given period.
Using the Fibonacci retracements tool in your trading platform you draw a line from the swing low to swing high
Then the Fibonacci retracement levels are automatically calculated by the trading platform.
The most popular Fibonacci retracement levels are 38.2%. 50% and 61.8%
It is widely agreed by the technical trading community that most moves will retrace around the Fibonacci levels, specifically around 50% of the move.
Fibonacci retracement levels work best in conjunction with other technical indicators, particularly RSI.