Fibonacci Retracements Trading Strategy
Fibonacci Retracements are ratios used to identify potential reversal levels. These ratios are found in the Fibonacci sequence. The most popular Fibonacci Retracements are 61.8% and 38.2%. Note that 38.2% is often rounded to 38% and 61.8 is rounded to 62%. After an advance, chartists apply Fibonacci ratios to define retracement levels and forecast the extent of a correction or pullback.
Fibonacci Retracements can also be applied after a decline to forecast the length of a counter-trend bounce. These retracements can be combined with other indicators and price patterns to create an overall strategy.
- Retracement levels alert traders or investors of a potential trend reversal, resistance area or support area.
- Retracements are based on the prior move. A bounce is expected to retrace a portion of the prior decline, while a correction is expected to retrace a portion of the prior advance.
- Once a pullback starts, chartists can identify specific Fibonacci retracement levels for monitoring. As the correction approaches these retracements, chartists should become more alert for a potential bullish reversal.
The Fibonacci Retracements shows four common retracements: 23.6%, 38.2%, 50%, and 61.8%. From the Fibonacci section above, it is clear that 23.6%, 38.2%, and 61.8% stem from ratios found within the Fibonacci sequence.
The 50% retracement is not based on a Fibonacci number. Instead, this number stems from Dow Theory’s assertion that the Averages often retrace half their prior move.
Based on depth, we can consider a 23.6% retracement to be relatively shallow. Such retracements would be appropriate for flags or short pullbacks.
Retracements in the 38.2%-50% range would be considered moderate. Even though deeper, the 61.8% retracement can be referred to as the golden retracement. It is, after all, based on the Golden Ratio.
Shallow retracements occur, but catching these requires a closer watch and quicker trigger finger.