38.2 Fibonacci Retracement Level
Ariadna Parrent
Now, the expectation is that if AUD/USD retraces from the recent high, it will find support at one of those Fibonacci retracement levels because traders will be placing buy orders at these levels as the price pulls back.
The expectation for a downtrend is that if the price retraces from this low, it could possibly encounter resistance at one of the Fibonacci levels because traders who want to play the downtrend at better prices may be ready with sell orders there.
If enough market participants believe that a retracement will occur near a Fibonacci retracement level and are waiting to open a position when the price reaches that level, then all those pending orders could impact the market price.
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In technical analysis, Fibonacci retracement levels indicate key areas where a stock may reverse or stall. Common ratios include 23.6%, 38.2%, and 50%, among others. Usually, these will occur between a high point and a low point for a security, designed to predict the future direction of its price movement.
As one of the most common technical trading strategies, a trader could use a Fibonacci retracement level to indicate where they would enter a trade. For instance, a trader notices that after significant momentum, a stock has declined 38.2%. As the stock begins to face an upward trend, they decide to enter the trade. Because the stock reached a Fibonacci level, it is deemed a good time to buy, with the trader speculating that the stock will then retrace, or recover, its recent losses.
Fibonacci retracements are trend lines drawn between two significant points, usually between absolute lows and absolute highs, plotted on a chart. Intersecting horizontal lines are placed at the Fibonacci levels.
When I was first introduced to Fib levels, I was only focusing on the 38.2 and 61.8% for any trading strategy. Why? The fact is I can put all the levels on a chart and price will bounce from one of them.
The first thing you should do is edit your levels and only show the 38.2% and 61.8% level as those are used in our strategy. Other numbers are not needed at this point as we are keeping this Forex trading strategy using Fibonacci, simple.
To cover the trading strategy, I am going to use one of the charts I talked about in my free Forex trading setups I post every single week. We are going to look at the GBPAUD four hour time frame chart which will also teach you how to use price action to determine if there is a high probability trading play in the works.
The good thing about higher time frame charts is you have less choice which can help you become a more disciplined trader. You may miss setups but often times, like the Forex chart I am using to explain the trading strategy, you can infer what the lower time frames is doing.
Lower time frame charts could help with trade entry when you find a setup. Looking for resumption of momentum in the original trend direction can get you in a trade earlier than a higher time frame such as a daily chart or four hour chart.
You can see the momentum push to the downside on both the four hour chart and the daily inset chart. Strong momentum in one direction often leads to another move in that direction. After using the Fibonacci tool to plot our 38.2% and 61.8% retracement levels, we start to monitor price.
Since we are selling a rally, we want to enter a sell stop order below the low of the small candlestick. You can drop even lower (since we did use higher time frame for the levels) to see what price action is doing. We can infer from the high shadow and open and closing price that the lower time frame has settled into a smaller trading range.
Once the trade is moving, the first roadblock is potential support at the bottom pivot. If risk reward allows it, scale out a portion of your trade here. Keep in mind that the market does not care about risk to reward and holding on for a 1:3 risk reward move when price action is not showing it, is stupid.
I mentioned that 61.8% levels show a deeper pullback and when found at trend turning points, they can reap you more pips than you can ever dream about. This next chart is going to show a great confluence (one my favorites) as well as show the 78.6% Fib level that I find useful at certain points in the chart.
For this trading strategy, when trading a 61.8% bounce, we are fairly close to the pivot and due to the higher swing low to the left of the bottom pivot area, the stop was placed just below that red zone.
Your trade entries will not be perfect and you may want to consider a multiple time frame approach when it comes to the trade entries. I use that a lot on the setups I post and in my own trading regardless of the market I am looking at.
A great thing about Fib levels is it will ensure you are zoning in on the chart and using small sections to look for trading setups. Support and resistance levels combined with a 38.2% or 61.8% Fib level plus confirming price action is a good technical analysis approach.
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Fibonacci retracement levels are represented as horizontal lines on a chart. The set of lines are placed between two points of interest on a chart. Typically a range that is created from a high and low price point.
The Fibonacci levels are often thought of as marking significant levels in the market. For this reason, traders also use Fibonacci retracement levels to find areas of support and resistance which also indicate where a trend is slowing down or reversing.
When adding Fibonacci retracement lines to a chart in an uptrend, the highest price should sit at the 0 (0%) line, and the lowest price at the 1 (100%) line. In this case, a full retracement requires a move from the high price back down to the low price. When charting an asset in a downward trend, set the lowest price at the 0 (0%) line and the highest price at the 1 (100%) line.
Ultimately, the insights gained from analyzing the Fibonacci retracement levels should be paired with a confirming indicator, such as the relative strength index (RSI) which measures strength or weakness as a function of buying or selling volume.
The combination of price hitting a Fibonacci level, paired with a confirming indicator such as the RSI, can help traders enter and exit trades at better prices and with more confidence. This combination can also used to help you determine where your stop-loss order should be placed.
In the example chart above, a 1-day RSI has been added as a confirming indicator. In this example of a BTC-USD 1-Day chart, we are using the retracement lines to find the best price to enter a trade. The candle on the purple line wicks perfectly to the 0 (0%) line making a full retracement from the highs at 65005.54.
On its own, this may not tell us much, but we can also see that the RSI became oversold at the same time. The market became oversold at that point, which suggests that sellers have become exhausted, providing a higher likelihood of a pause or reversal in the downtrend.
Fibonacci retracement levels are not a fool-proof method and should always be used in conjunction with a confirming indicator such as the relative strength index (RSI), volume, or exponential moving average (EMA).
To plot a Fibonacci retracement onto a chart in a downtrend, start at the high price and drag your centerline to the low price. To add the retracement to a chart in an uptrend, start at the low price and drag the centerline to the highest price point.
The topic of Fibonacci retracements is quite intriguing. To fully understand and appreciate the concept of Fibonacci retracements, one must understand the Fibonacci series. The origins of the Fibonacci series can be traced back to the ancient Indian mathematic scripts, with some claims dating back to 200 BC. However, in the 12th century, Leonardo Pisano Bogollo, an Italian mathematician from Pisa, known to his friends as Fibonacci discovered Fibonacci numbers.
The ratio of 1.618 is considered as the Golden Ratio, also referred to as the Phi. Fibonacci numbers have their connection to nature. The ratio can be found in the human face, flower petals, animal bodies, fruits, vegetables, rock formation, galaxy formations etc. Of course, let us not get into this discussion as we would be digressing from the main topic. For those interested, I would suggest you search on the internet for golden ratio examples, and you will be pleasantly surprised. Further into the ratio properties, one can find remarkable consistency when a number is in the Fibonacci series is divided by its immediate succeeding number.
It is believed that the Fibonacci ratios, i.e. 61.8%, 38.2%, and 23.6%, finds its application in stock charts. Fibonacci analysis can be applied when there is a noticeable up-move or down-move in prices. Whenever the stock moves either upwards or downwards sharply, it usually tends to retrace back before its next move. For example, if the stock has run up from Rs.50 to Rs.100, it is likely to retrace back to probably Rs.70 before moving Rs.120.
Here is another example where the chart has rallied from Rs.288 to Rs.338. Therefore 50 points move makes up for the Fibonacci upmove. The stock retraced back 38.2% to Rs.319 before resuming its up move.
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