Fibonacci retracement

A retracement is a pullback against the main move. After a rally from 100 to 200, a drop to 150 is a 50% retracement: price gave back half of the rally.

Fibonacci retracement places horizontal lines at fixed shares of a move. The shares come from the Fibonacci sequence, described by Leonardo of Pisa in 1202. The tool rests on an observation, not a law: pullbacks often end near these levels, in part because so many traders watch them.

0% and 100% mark the end and the start of the measured move. For a rally from 100 to 200 the levels are 176.4, 161.8, 150, 138.2 and 121.4.

• 23.6% – a shallow pullback. It is seen in strong trends, where price barely pauses.
• 38.2% – a moderate pullback. A trend that holds this level is read as strong.
• 50% – half of the move. It is not a Fibonacci ratio, but it is on every Fibonacci tool because traders have used the halfway point since Dow theory.
• 61.8% – the golden ratio and the most watched level. The area between 50% and 61.8% is where many traders look for entries.
• 78.6% – a deep pullback and the last level before the start of the move. When price closes beyond it, traders often expect a return to the start of the move.

On Charts, Fibonacci retracement is one of the drawing tools: set the first point at the start of the move and the second at its end. Market structure shows which swings to use.

• Find a clear, finished move: a swing low and a swing high with no larger swing between them.
• In an uptrend, draw from the swing low to the swing high. The levels show where a pullback down may find support.
• In a downtrend, draw from the swing high to the swing low. The levels show where a bounce up may meet resistance.
• Use the extremes of the wicks, and use the same method every time.
• Redraw only when price makes a new swing high or low. Do not move the anchor points to make the levels fit.

• Direction – only with the move you measured: longs on a pullback in an uptrend, shorts on a bounce in a downtrend.
• Entry – at a level where price shows a reaction: a long wick, a hammer or a bullish engulfing candle for longs. The 50–61.8% area is the usual choice.
• Stop – beyond the next level, or beyond the 100% point for a wider stop.
• Target – the 0% level, which is the previous high or low. Beyond it traders use the extension levels 127.2% and 161.8%.

A Fibonacci level alone is a weak reason for a trade. It carries more weight when it coincides with something else on the chart.

• A previous swing high or low – see support and resistance.
• An order block or a fair value gap left by the move.
• A moving average that the trend has respected.
• A round number.

In the Fibonacci sequence each number is the sum of the two before it: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55. Divide a number by the next one and the result approaches 0.618. Divide it by the number two places ahead and it approaches 0.382. Three places ahead gives 0.236. The 78.6% level is the square root of 0.618.

• Drawing on every small move – levels from a minor swing are noise. Use swings that stand out on the timeframe you trade.
• Drawing in the wrong direction – the levels must measure a pullback against the trend, not the trend itself.
• Expecting an exact turn – price often stops between levels or runs through one before turning. Treat each level as an area.
• Using the levels against the trend – a 61.8% pullback means little when the higher timeframe points the other way.