Fibonacci retracement is a technical analysis term referring to support or resistance areas. A retracement level uses horizontal lines to highlight areas of resistance or support that a trend must pass through before it can continue in its current direction.
These levels are made by making a trend-line between the chart’s low and high points, and then dividing the distance by key Fibonacci ratios.
Many traders use these levels to identify strategic places to take a position or to place profit takers and stop losses. The concept of retracement is employed in a number of indicators, such as the Gartley pattern, Tirone level and Elliott Wave theory.
Unlike a moving average, these levels are static prices. This static nature leads to quick and simple identification, which allows traders to foresee and react when a price level gets tested.
Some type of price action is expected at the inflection points, whether it is a break or a rejection.
How to Trade Using Retracement Levels
The levels are often used as a purchase trigger during pullbacks on an uptrend. It is ideal to use momentum indicators, such as a MACD or stochastic oscillator, to identify the best entry points. During a downtrend, they are used for short selling when a bounce rejects off a level.
A fortified level occurs when it overlaps with other indicators, such as the 200-day moving average, which is an even stronger indicator for resistance or support.
The most important level occurs at 0.618. This level is often the highest pullback area, where fear will climax as the last sellers give up and buyers pile in to resume the uptrend.
During a downtrend, the 0.618 level is often where the last buyers become exhausted as sellers unload their positions and short-sellers pile in to resume the downtrend.
Many traders will wait for two or three candlestick closes below or above the level for confirmation of resistance or support before they place a trade.