Fibonacci Retracements

What are Fibonacci retracements?

• Levels at which the market is expected to retrace to after a strong trend.

Based on mathematical numbers that repeat themselves in all walks of life, Fibonacci retracements attempt to measure the likely points that a currency pair will retrace, or pull back to within a range. The key numbers in FX trading are 38.2%, 50%, and 61.8%.

Consider the following example to see how Fibonacci retracements work:

Suppose an asset is on an uptrend, going from 0 and 1000. After the asset reaches 1,000, how far will it retrace – meaning how far will it fall – before resuming its initial uptrend? We can do this by using the Fibonacci retracement numbers to gauge how deep of a pullback we could expect after the top “boundary” is reached.

So, mathematically, it works like this:

• The 38.2% line. Calculate 38.2% of the size of the significant price move. The size of the significant price move in this case is (1,000) minus the lower boundary (0). In this case, the size of the significant price move is 1,000 pips. .382 x 1000 = 382 pips. It is expected that the asset will retrace 382 points from its peak. Assuming the asset is going up from 0 to 1,000, it would retrace 382 pips from 1,000. 1,000 – 382 = 618. Accordingly, this is a key level to look out for; you may want to buy here (at 618), as it is expected the upward trend will resume after reaching this retracement level.
• The 50.0% line. Same situation; 50% of the significant price move (1,000 pips) is 500. Take that off from top (1,000) since it is an the upward trend. 1,000 – 500 = 500. Look for the upward trend to resume at that point.
• The 61.8% line. 61.8% of the significant price move is 618. 1,000 – 618 = 382. If the asset retraces to this point, it is viewed as an opportunity to buy.

If the asset were trending lower – meaning it had gone from 1,000 to 0 – then you would use the Fibonacci numbers to calculate the retracement regarding how far the price may rise before resuming the downtrend again. You would calculate the Fibonacci retracements in the same manner, except you would draw from the high point of the significant price move to the low point of the move.

Parameters: 38.2%, 50.0%, and 61.8% are the most common Fibonacci Levels. The 38.2% level is considered the least significant of the three major Fibonacci levels. The larger the percentage line (i.e. 61.8%) the greater the likelihood that the price will find support.

Please keep in mind that other retracement levels exist in Fibonacci Studies that are not widely watched by the market. These levels include 21.4% and 78.6% as well as 127.2% and 161.8% extensions. Most charting packages do not even reference these levels and most traders would argue that if the market retraces 100% of a previous move, the original trend is no longer valid. Other Fibonacci studies called fans and arcs are quite mathematically complicated and are similarly ignored by most traders.

Key Concept: Look for Confirmation

• Traders should enter when confirmation - for example key candlestick patterns – emerge at Fibonacci levels. Traders can also seek confirmation from a variety of other indicators, as we will see as the course continues.