Fibonacci retracement is a popular technical analysis tool used in the stock market to identify potential levels of support and resistance. It is based on the Fibonacci sequence, a mathematical series where each number is the sum of the two preceding ones (0, 1, 1, 2, 3, 5, 8, 13, etc.). The key idea is that market movements tend to retrace a predictable portion of a move, often aligning with certain Fibonacci levels.
Key Fibonacci Levels:
The most commonly used Fibonacci retracement levels are:
23.6%
38.2%
50% (not officially a Fibonacci ratio but commonly used)
61.8%
78.6%
Steps to use Fibonacci retracement
1. Identify an inside day: The first step is to identify an inside day on the chart. This is a candlestick where the high and low are completely contained within the high and low of the previous day’s candlestick.
2. Draw Fibonacci retracement levels: Once you have identified an inside day, it’s time to draw the Fibonacci retracement levels. Start by drawing a line from the high of the previous day’s candlestick to the low of the inside day. Then draw another line from the low of the inside day to the high of the inside day. Finally, draw a third line from the high of the inside day to the low of the next day’s candlestick.
3. Look for confluence: The next step is to look for confluence between the Fibonacci retracement levels and other technical indicators. For example, if the 50% retracement level lines up with a key level of support or resistance, this could be a strong indication that the market will reverse at that level.
4. Use stop loss and take profit orders: Finally, it’s important to use stop loss and take profit orders when trading with Fibonacci retracement and inside days. By placing these orders at key levels of support and resistance, you can limit your losses and maximize your profits.
Fibonacci Retracement Buy Application
Case study 1 shows a buy trade on XAUUSD using the Fibonacci retracement tool.
Assuming a bullish bias, figure 1 shows an identification of a swing low to swing high on gold using the Fibonacci Retracement tool as indicated by the purple boxes.
