The Fibonacci retracement is defined as a technical indicator that identifies support and resistance levels. It has retracement levels of 0%, 23.6%, 38.2%, 50%, 61.8%, 78.6%, and 100%. The Fibonacci retracements, unlike other indicators, cannot generate buy and sell signals directly. They instead act as guides alongside other indicators to make sound trading decisions.
On the other hand, trend lines are technical analysis tools useful in identifying trend directions, i.e., the up and downtrend. Trend lines work best in identifying trend directions, while Fibonacci retracement works well in a trending market environment. Combining the two tools results in trades that have very high winning probabilities.
Performing a Fibonacci Retracement Analysis
To perform a Fibonacci Retracement Analysis, locate a solid downward or upward trend in the market. The analysis study range is the high and low trend points being analyzed. Calculating the Fibonacci retracement levels is based on two points:
Downtrend Fibonacci Retracement
Creating a Fibonacci retracement in a downtrend picks the highest and lowest prices. The pair defines where you will calculate the Fibonacci levels from. The downtrend levels are calculated via this formula:
Fibonacci Price Level= Low Price + (High Price-Low Price) x Fibonacci Level
The Fibonacci level refers to the levels from the above calculation, e.g., 38.2%, 61.8%, 23.6%, etc. Once the levels are calculated, the levels are indicated on the price chart to guide future resistance or support levels.
Traders can use the Fibonacci levels to alert themselves to make better trading decisions. For instance, if the price gets to a certain level of resistance, the traders may opt to place a sell order and maximize their profits.
Uptrend Fibonacci Retracement
Fibonacci Price Level=High Price- (High Price- Low Price) x Fibonacci Level
The Fibonacci levels used are similar to the downtrend calculations, i.e., 38.2%, 50%, 61.8%, and 78.6%. In an uptrend, traders can use the Fibonacci levels for placing buy orders when a particular resistance level is arrived at. The bet is generally on the price will be at the lowest and will likely spring back.
How to Draw a Trend Line
- On your chart’s top left side, the / or the small slanting line is the trend line
- Pick the tool using your cursor, click, then hold and drag to the chart.
- For an uptrend or support trendline, try to connect the line from one wave’s low to the next high low.
- Extend the line outwards to the right to give you a projection of the subsequent lows’ occurrences.
- For a downtrend or resistance trendline, connect one price wave’s high to the lower high of the following price wave, then extend it outwards to the right. This line gives you a projection of where the next wave highs might occur.
- The line should pass through at least two to three points of the higher lows or low highs for an up and downtrend.
How to draw a Fibonacci retracement on the chart
There is a tiny dotted line with a letter F below it on the chart’s top left side. Click on it and move (not drag) your cursor towards the chart.
- For an uptrend, start by picking a lower low. Placing the Fibonacci icon, click, hold and drag upwards for a connection with the higher end (swing)
- Release cursor and left-click your mouse
- For a downtrend, start by picking a higher high and placing the Fibonacci icon, clicking, holding, and dragging downwards for a connection with the lower low end (swing)
- Release the cursor and left-click the mouse.
After drawing both the trend line and Fibonacci retracement, you need to identify any intersection level between the trend line and the Fibonacci levels.
Rules on how to use Fibonacci retracement with Trendlines
First, identify the trendline, which already gives you two points. The next thing you do is to draw the Fibonacci retracement on the following swing wave. Look out for zones where the Fibonacci levels intersect with the trendline. Wait for the confirmation as the price reaches the intersection point. The confirmation comes in a candle in the direction of the trend.
Remember that you take the reversals or bounces on retracement levels in the primary trend’s direction when you are trading the Fibonacci retracement. The intersection of the Fibonacci and trendline determine your buying and selling entry points.