How to Use Fibonacci Retracement? [EXPLAINED]


Let’s talk Fibonacci retracement, shall we?

What are Fibonacci Retracement Levels?

Fibonacci retracement levels are considered a predictive technical indicator that works on the theory that after price begins a new trend direction, the price will often return – or retrace – part way back to the previous price level before resuming in the original direction.

Forex traders use these Fibonacci retracements as potential support and resistance areas and they believe that it works best when the market is trending.

The idea is to go long (buy) on a retracement at a Fibonacci support level when the market is in an UPTREND.

And to go short (sell) on a retracement at a Fibonacci resistance level when the market is in a DOWNTREND.

So in practice, the numbers and formulas that feed into your retracement levels may allow you to predict future price points.

Finding Fibonacci Retracement Levels

In order to find and apply Fibonacci levels to the chart, you’ll need to identify Swing High and Swing Low points.

Swing High is a candlestick with at least two lower highs on both the left and right of itself.

Swing Low is a candlestick with at least two higher lows on both the left and right of itself.

swing high swing low

Then, for downtrends, click on the Swing High and drag the cursor to the most recent Swing Low.

For uptrends, do the opposite. Click on the Swing Low and drag the cursor to the most recent Swing High.

It will look something like this.

fibonacci swing low swing high

Let’s explore these in more detail below.

Fibonacci Retracement Levels in an Uptrend

Let’s use this daily AUD/USD chart as our example of using Fibonacci Retracement Levels in an uptrend. 

fibonacci retracement

You can see that we plotted the Fibonacci levels on the swing low at 0.6955 on 20th April and dragged the cursor to the swing high at 0.8264 on the 3rd June.

Once we’ve done that, the charting software (MT4) showed us the retracement levels. 

As you can see, the retracement levels were 0.7955 (23.6%), 0.7764 (38.2%), 0.7609 (50.0%), 0.7454 (61.8%), and 0.7263 (76.4%).

Now, we were expecting the AUD/USD to retrace from the recent high and find support at on of the Fibonacci retracement levels because traders would be placing buy orders at these levels as price pulls back.

Let’s have a look at what happened next.

fibonacci retracement

The price pulled back right through the 0.7955 level and continued to shoot down over the next couple of weeks.

It even tested the 0.7764 level but it was unable to close below it.

Then some time around 14th July, the market resumed its upward move and eventually broke through the swing high.

So if you were to buy at the 0.7764 (38.2%) Fibonacci level, it would quite clearly made a profitable long-term trade.

Fibonacci Retracement Levels in a Downtrend

Let’s use this daily EUR/USD chart as our example of using Fibonacci Retracement Levels in a downtrend. 

fibonacci retracement

You can see that we plotted the Fibonacci retracement levels on the swing high at 1.4195 on 25th January and dragged the cursor to the swing low at 1.3854 on the 1st February.

Once we’ve done that, the charting software (MT4) showed us the retracement levels. 

As you can see, the retracement levels were 1.3933 (23.6%), 1.3983 (38.2%), 1.4023 (50.0%), 1.4064 (61.8%) and 1.4114 (76.4%).

Now, we were expecting the EUR/USD to retrace from the recent low and potentially encounter resistance at on of the Fibonacci retracement levels because traders who want to play the downtrend at better prices may be ready with sell orders there.

Let’s have a look at what happened next.

fibonacci retracement

Isn’t that beautiful?

The market did try to rally, stalled below the 1.3983 (38.2%) level for a bit before testing the 1.4023 (50.0%) level.

If you had placed orders at the 38.2% or 50.0% levels, you would have made some mad pips mate!

Wrapping Up

In our two examples above, we were lucky enough to find some temporary support and resistance at Fibonacci retracement levels.

However, it is important to remember that while Fibonacci retracement levels give you a higher probability of success, price won’t ALWAYS bounce from these levels, and these levels should be looked at only as areas of interest. Not definite indicators.

And that brings me to our next topic. In the next lesson, we will show you why it is important to hone your skills and combine the Fibonacci retracement with other tools, such as support and resistance levels and candlesticks, to give you a higher probability of success.