In this article, I’m going to show you how to apply Fibonacci retracement levels to a chart and what information it provides. Remember, indicators “indicate” possible price moves and entry-exit points. You’ll still need to interpret the data for yourself, so I’ll show you how to do that too.
Let’s break down the words Fibonacci and retracement to better understand what this tool does.
Fibonacci was an Italian mathematician who discovered a sequence of numbers that occurs in nature. This infinite sequence is created by adding together the preceding two numbers on the list to create the next number. For example: 0, 1, 1, 2, 3, 5, 8, 13, 21, etc.
Retracement refers to how a price trend can sometimes temporarily fall back before continuing in the direction of the trend.
The Fibonacci Retracement tool helps traders identify levels for setting Buy Stop Limits or Sell Stop Limits that can activate orders whenever a price retracement occurs. The indicator lines also help when searching for a trading entry point level on a trending price move.
Open your Exness demo account and let’s apply the Fibonacci tool to a chart. EURGBP often displays volatility. It’s a perfect pair to demonstrate how the Fibonacci tool can help you set a more profitable order prior to a price retracement. On the top menu of your trading platform, set the timeframe to H4 (4 hourly) and display the price as a line.
Go to the top menu >> Insert >> Fibonacci >> Retracement
On the chart, draw a line at the start of a trend to the point of reversal by holding down the left mouse button until you get to the break.
If a retracement occurs, how low will it go? That’s where the yellow lines or levels can help with your forecasting. The displayed Fibonacci levels or lines offer several entry points. Assuming the trend continues, the higher the line value the greater the profit. These entry points levels can be customized, but most traders don’t mess with the defaults. So which level should you choose for your entry point?
In the example above, EURNZD started a bull run at 4:00 pm on March 26. A retracement began four hours later. The Fibonacci tool displays six levels ranging from 0.0 (no retracement) to 100.0 (full reversal). Choosing the right level is ultimately your decision, but the Fibonacci levels work as an effective guideline or benchmark. Just remember that an indicator is not a time machine and market prices don’t always follow the mathematical rules.
23.6: A small move that happens all the time and offers limited value or improved profitability.
38.2: An accurate forecast at this level creates attractive profits, and the likelihood of it occurring remains quite high.
50.0: Half retracement. Not a tall order by any means, but the improvement to your profit ratio improves significantly—compared to opening a position on the high.
61.8: Entering the realm of more and more unlikely. To catch such a reversal in the middle of a rally is a long shot, but highly profitable when it happens.
Most conservative traders will probably set entry levels between 23.6 and 50.0 but that number will rise as your knowledge and experience grows.
In the example above, the reversal dropped to the 38.2 mark and then continued to rally well beyond the price at the time of drawing the Fibonacci lines.
Remember, market prices won’t always fit in with Fibonacci levels so perfectly. Many unexpected changes can and will affect your orders if you trade on a daily basis. Most traders agree that the longer the timeframe and greater the price difference, the more accurate the forecast.
Trading indicator tools can be likened to comments on Amazon. You’ll get better results in the long-term if you take more than one into consideration, so work hard and use other indicators together with fundamental analysis.
Test the Fibonacci trading tool on a real or demo account
Not sure how to get started? No problem. Follow this step-by-step guide.