Fibonacci retracements are a valuable tool for both day trader and swing trader. The most popular Fibonacci Retracement levels are 38.2%, 50%, and 61.8%. These levels are often where a stock, after a big move up, will retrace or pull back to. Knowing these amazing levels can help you better time your entry in a stock. Don't chase it, Fibonacci Retracement.
The Fibonacci sequence is a series of numbers derived by adding up the two numbers before it. Here is an example of a Fibonacci sequence:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, …
The Fibonacci sequence appears in nature such as in the arrangement of leaves on a stem, the flowering of an artichoke, the fruit sprouts of a pineapple, and more.
Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci sequence. The key Fibonacci ratios applicable to stock trading are 23.6%, 38.2%, and 61.8%.
How To Use Fibonacci Retracement
Fibonacci retracement levels mark potential reversal levels. After an extended move up, a correction is expected as profit taking kicks in. That correction can be a Fibonacci retracement. After a move down, a bounce is expected as short sellers take profits. That bounce can be a Fibonacci retracement.
A Fibonacci retracement of a downtrend looks like this:
A Fibonacci retracement of an uptrend looks like this:
Fibonacci Retracement Tool
My favorite Fibonacci retracement tool is the one that comes with a membership to StockCharts.com.
Click on “Annotate” at the bottom of any chart:
Now click on the Fibonacci retracement tool at the top of the window:
Top 5 Fibonacci Retracement Mistakes To Avoid
Fibonacci retracements done the wrong way can cause you to lose a lot of money. Below are five Fibonacci retracement rules you should follow.
Fibonacci Retracement Rules
1. A Fibonacci retracement level should not be used by itself. It should be used with other technical analysis tools as part of a larger stock trading system.
3. Is the Fibonacci retracement level occurring at a major support level where there is a history of the stock bouncing off that level?
4. Is there a breaking news story or catalyst that was released as the stock nears a Fibonacci retracement level?
5. What is the longer term trend in the stock? Has the stock been forming a series of higher lows and higher highs? If so, is the Fibonacci retracement in the uptrend channel off the lower channel wall?
Frequently Asked Questions about How To Use Fibonacci Retracements
What are Fibonacci retracement levels?
Fibonacci retracement levels are areas on a chart where a stock will often pull back to after an uptrend, or bounce to after a downtrend. The major Fibonacci retracement levels are 23.6%, 38.2%, and 61.8%. Below is a very good Fibonacci retracement tutorial that was done by TradingAcademyMumbai with Derek Zalek.
How do you use Fibonacci retracements?
How you use Fibonacci retracements depends on your larger trading strategy and style.
If you trade a 38.2% Fibonacci retracement, the risk versus reward ratio is not going to be good. There is usually not enough profit to be made on a 38.2% Fibonacci retracement. You need the market to pullback a lot more than that.
The retracements that you should be going for are 50% and 61.8%. These are the only two Fibonacci retracement levels that you should be trying to trade.
If a retracement exceeds 61.8%, you do not want to trade it because it most likely marks a new downtrend. The reason is that institutional traders and money managers sold too much of the stock for it to continue in an uptrend.
Manesh Patel posted an awesome video from ichimokutrade and an Atlanta Meetup group where the question how do you trade with Fibonacci retracement levels was answered.
What is a Fibonacci retracement chart?
A Fibonacci retracement chart is a chart that shows the major Fibonacci retracement levels as an overlay.
Most charting software has the most popular Fibonacci retracement levels of 38.2%, 50%, and 61.8%.
I use StockCharts.com for my Fibonacci retracement charts.
When using a Fibonacci retracement chart overlay, pay particular attention to areas that also correspond with major support and resistance levels. In the Fibonacci retracement chart above, I have extended the 38.2% retracement level with a dotted line to show the major support area it corresponds with. Note that previous resistance often turns into support after a breakout and that's why the $4.40 support area is key.
BillPoulos posted the excellent video below called Fibonacci Trading.
Elprimermatador posted the great video below called Fibonacci Retracements.
How to draw Fibonacci retracement lines.
Fibonacci retracement lines are usually drawn at the 38.2%, 50%, and 61.8% retracement levels.
The starting point for drawing Fibonacci retracement lines can be: major support and resistance levels, swing move highs, swing move lows, and trend channel lows and highs.
The starting point of a Fibonacci retracement going from high to low is for shorting. The starting point going from low to high is for going long. Therefore, you need to establish the larger trend before drawing your Fibonacci retracement lines.
Stock Option Assassin posted the excellent video below called How to use the Fibonacci Retracement Tool.
Why do Fibonacci retracements work?
Fibonacci retracement levels sometimes work because they usually fall at major support and resistance levels.
The key to using Fibonacci retracement levels is to see if they correspond to other major support and resistance levels.
A Fibonacci retracement level by itself is nothing magical. A price bounces or turns based on buyers and sellers. When there are more buyers than sellers, a stock goes up. When there are more sellers than buyers, a stock goes down. It's a supply and demand equation. This is why you should always make sure that you are using Fibonacci retracement levels with other chart patterns, candlesticks, and technical and fundamental indicators.
Fxinfoonline posted the excellent video below called Fibonacci Retracements and Number Sequence – Why they Don't Work in Forex Trading. What Fxinfoonline says for the Forex market also holds true for the stock market. This is a controversial video but it's important that you hear a critical analysis of Fibonacci retracement levels because, after all, it's your own hard earned money at stake.
I had a huge winner in the stock Real Goods Solar (RSOL). I entered on Friday, May 24th 2013 at around $3.83 and one trading day later, I sold around $4.47: a whopping 15%+ profit in just 1 trading day! I used the 61.8% Fibonacci retracement level in the daily time frame to work this swing trade entry.