Fibonacci Retracement Levels

In an uptrend, the general idea is to go long the market on a retracement to a Fibonacci support level. The price retracement levels can be applied to the price bar chart of any market by clicking on a significant Swing Low and dragging the cursor to the most recent potential Swing High and clicking there. This will display each of the Retracement Levels showing both the ratio and corresponding price level. Let’s take a look at some examples of markets in an uptrend. The same points made by these examples are equally applicable to markets in a downtrend.

Example 1:

Here we plotted the Fibonacci Retracement Levels by clicking on the Swing Low at about $71.31 and dragging the cursor to the Swing High at about $89.83. You can see the resultant levels plotted by the software. Now the expectation is that if the market retraces from this high it will find support at one of the Fibonacci Levels, because traders will be placing buy orders at these levels as the market pulls back.

Example 1.1:

Now let’s look at what actually happened after the Swing High occurred. The market pulled back right through the 0.236 level and continued the next day through the 0.382 level before finding support. After a few days, the market resumed its upward move. Clearly buying at the 0.382 level would have been a good short term trade.

Example 2:

Again, the Fibonacci Retracement Levels were plotted on the chart in the same manner as described in Example 1. Again, we are looking for the market to retrace from the Swing High and find support at one of the Fibonacci levels.

Example 2.1:

Now let’s look at what actually happened. The market again pulled back right through the 0.236 level and continued to pull back until it found temporary support at the 0.50 level (a lot of buyers at this level). However, once the buying power was exhausted, the market continued to retrace all the way down to the 0.764 level before resuming its upward trend. In this case, buying at the 0.764 level would have been a good short term trade.

Example 3:

Here’s another example. If the market retraces from the Swing High, where will it find support?

Example 3.1:

Well, in this case the market found support at the 0.50 level. Buying at this level would have been a great trade as the market gapped up a few days later.

Example 4:

Here’s one more example.

Example 4.1:

Whoops! The market gapped down through all levels of support and never looked back. A long trade here would have been a loser or at least an open lose position.

You can see from these examples that the market often finds at least temporary support at the Fibonacci Retracement Levels – not always, but often. It should be apparent that there are a few problems to deal with here. First, there is no way of knowing which level will provide support. The 0.236 level seems to provide the weakest support, while the other levels provide support with approximately the same frequency. Second, the market will not always resume its uptrend after finding temporary support, but instead continue to decline below the last Swing Low.

Thirdly, placement of stops is a challenge – it is probably best to place stops below the last Swing Low, but this requires accepting a high level of risk in proportion to the likely profit potential in the trade. Another problem is determining which Swing Low to start from in creating the Fibonacci Retracement Levels. One way is from the last Swing Low as we did in the examples. Another is from the lowest Swing Low of the past 30 days. The point is, there is no one right way to do it, and consequently it becomes a guessing game.