Many traders use some form of Fibonacci Retracements to help them determine possible points of Support or Resistance in a market. Fibonacci Retracements answer the question, “Where is the current retracement of a prior price swing likely to find support or resistance?”
To begin using Fibonacci Retracements, it is helpful first to define the current trend. For this example, let us assume we are looking to ask where a current corrective swing down after a large move up will find support, so perhaps we can establish a trade in the direction of the prevailing trend at a low-risk, high probability inflection point.
Let’s look at an ideal diagram:
How to Draw a Fibonacci Retracement Grid:
1. Identify a Trend (we will assume an up-trend)
2. Find the recent swing high in price where price is now showing downward movement
3. Find the most recent swing low
4. Start at the perceived Swing High and draw a Fibonacci Grid (retracement tool) down to the Swing Low
Your software should now fill in the 38.2%, 50.0%, and 61.8% retracements of the swing you are measuring.
In a strong uptrend, price should find support and ‘inflect’ off the 38.2% retracement of the swing, but if not, it would be expected to find support at the 50.0% (one-half) retracement. A deeper retracement would take price to the 61.8% retracement, but if price does not find support and reverse off any of these levels, it would generally be a good idea to take your stop-loss and prepare for the possibility of a market reversal.
Fibonacci levels give good places to enter trades and place stops close to entry, giving the possibility for a low-risk trade idea, particularly if it is confirmed by signals from other indicators or timeframes.