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Part II. Fibonacci Retracement

Fibonacci Retracement - Forex School
Commander in Pips: Today we will focus on Fibonacci retracement. Do you remember what ratios we should use for retracement calculation?

Pipruit: Sure – here they are: 0.382; 0.5; 0.618; 0.786; 0.886; 1.0. Also there are a couple of minor ratios - 0.236 and 0.707.​

Ratios of fibonacci retracement - Forex School
Commander in Pips: Excellent. By the way, if you really want to study extremely powerful and useful approach to applying Fibonacci on financial markets, I strongly recommend you to read Joe DiNapoli's book “Trading with DiNapoli levels”. Although it’s not new, and possibly needs a second edition, many tools that are described in this book work extremely well.

But let’s start with important rules:

1. It’s preferable that the market shows a thrusting move for application of retracement;

2. The major rules for using retracement as follows: “Buying deeps or selling rallies”. What does it mean?

- “Buy deeps” rule applies during a market up thrust and means that we should buy from one of retracement levels. In this case Fibonacci retracement levels act like support levels;

- “Sell rallies” rule applies during a market down thrust and means that we should sell from one of retracement levels. In this case Fibonacci retracement levels act like resistance levels.

Now, let’s study the proper way to calculate retracement levels and we will start from an upward thrusting move.

To make our further discussion simpler, let’s appoint some terms first:

1. “X” point will stand for starting point of thrust, that will be used for building a retracement;

2. “A” point will stand for final point of thrust that will be used for building a retracement.

So, here is how we will mark the thrusting move from which we would like to estimate retracement levels - “X-A”. In our terms the move on the market will always develop from X to A. It means that during the up thrust X-A, the move will be ascending, and during down thrust – descending.

Upward thrust

As we’ve noted in previous part of current chapter, to calculate retracement we have to estimate swing high and swing low – i.e. the highest point of the thrust and the lowest point of the thrust.

Pipruit: X and A points, in other words…​

Commander in Pips: Right. Since, an up thrust develops from lower levels to higher levels, then the starting of the thrust, which is our “X” point” will be the swing low. And “A” point will be the swing high…

Pipruit: … because up thrust ends at higher levels, which is also a final point of thrust​

Commander in Pips: Absolutely. So, remember two important rules:

1. We use strictly high and low prices for estimating A and X points. Not open, not close not some average – strictly extremes.

2. During up thrust the “A” point will always be the most recent high price and it has to stand later in time than X point – to the right side from X on the chart.

Commander in Pips: Ok, mark for me X and A points here:

Upward thrust - Forex School
Pipruit: Ok, let’s see. First I’ll mark an A point, because, as you’ve said – this is always will be the most recent maximum price. And then, X point is easier to see – here it is, the lowest price of the thrust:​

X and A point on Fibonacci - Forex School
Commander in Pips: Well done, son. I see that you understood this right. Now let’s discuss how to calculate retracement levels.

1. All retracement levels will be below the A point and stand between the X and A points – i.e. stand inside the “XA” range;

2. To estimate any retracement level you should apply the formula: A - (A-X)*ratio. For instance, if A=1.3854 and X=1.3710, then 0.382 level = 1.3854-(1.3854-1.3710)*0.382 = 1.3799.

So, now is your turn - estimate 0.786 level…

Pipruit: So, 1.3854-(1.3854-1.3710)*0.786 = 1.3741.​

Commander in Pips: That’s right, so if we will calculate all levels in the same way and then draw them on the chart, we will get the following picture:

Fibonacci Retracement Levels - Forex School
Pipruit: Looks great – I see my level there! But Sir, do we have to do it always manually?​

Commander in Pips: Surely not. For this purpose almost any software has so called Fibonacci retracement tool. To draw the levels from up thrust you should accomplish the following procedure:

1. Click to “X” point of the thrust;

2. Drag the mouse up to “A” point and release the button. Levels should look like on the picture – the closest to “A” should be 0.382, then 0.5 etc.

3. If your levels after points 1 and 2 look opposite – the closest to “A” point is 0.886, then 0.786 etc. - some software assumes opposite procedure – you should drag mouse from A to X point. Do this, and you will get proper levels.

So, let see what has happened with our levels then. Look at the chart #1. This is 60-min EUR/USD chart, by the way…:

#1 Chart 60-min EUR/USD
 EUR/USD 60- min Chart - Forex School
Can you comment this chart somehow? I even made notes, so it’s not so difficult task…

Pipruit: Ok, as we’ve said, Fibonacci Retracement levels should act like support, if they build from up trust. These levels we can use for entering on long side of the market. First, I see, that 0.382 level was absolutely disrespected by price action – no sign of support. The first level that has supported the market was 0.5. But after some time it also has been broken to the downside. Then, you’ve marked that it has become a resistance – now I see it. Here I can make a conclusion that not only trend lines and support/resistance levels have this feature, but retracement levels also. Then the market reached 0.618 support that has held the price for some time. And finally, market has reached deep 0.786 support, that market was not able to break and then reestablished the up move.

But, Commander, how we could know, which level will support the market. Where we should buy from?​

Commander in Pips: You can’t know it only from retracement application. Because the purpose of retracement levels is just to give you possible levels of support ahead of time to watch for, to warn you like a beacon – “Hey, here support is possible!” The quality of these levels is the same as of trend lines or non-Fibonacci support/resistance levels. To get some answer – where market could reestablish up move, you have to combine Fibonacci levels with other tools. How to do that? You will learn in later chapters. But still, a level itself could give you some prompting – you just have to be very attentive to non-obvious details.

Think, what the fact of total disrespection of 0.382 level tells us?

Pipruit: … that the market is weaker than it seems?​

Commander in Pips: Of course, and, hence, that is deeper retracement is more probable. So, if market totally disrespects 0.382 or even 0.5 also, then, the more probable that it will reach 0.786-0.886 levels at least, rather than stop at 0.618 and turn up again. Just be attentive!

Pipruit: I see. Thanks, Commander, this is very useful information.​

Commander in Pips: Ok, now let’s take a look at Fibonacci retracement from a down thrust. This is almost the same, so, I give you the description briefly.

Downward thrust

1. Since a down thrust develops from higher levels to lower levels, then the starting of the thrust, which is our “X” point” will be swing high. And “A” point will be swing low, because the down thrust ends at lower levels, which is also a final point of thrust;

2. We use strictly high and low prices for estimating X and A points. Not open, not close not some average – strictly extremes;

3. During a down thrust the “A” point will be always the more recent low price and it has to stand later in time than X point – to the right side from X on the chart;

4. All retracement levels will be above the A point and stand between the X and A points – i.e. stand inside the “XA” range;

5. To estimate any retracement level you should apply the formula: A + (X-A)*ratio;

6. To draw the levels from a down thrust you should accomplish the following procedure:

- Click to “X” point of the thrust;

- Drag the mouse down to “A” point and release the button. Levels should look like those on chart #2 – the closest to “A” should be 0.382, then 0.5 etc;

- If your levels after points 1 and 2 look opposite – the closest to “A” point is 0.886, then 0.786 etc. - some software assumes opposite procedure – you should drag mouse from A to X point. Do this, and you will get proper levels.

7. Retracement levels from a down thrust act like resistance.

Chart #2 EUR/USD 60-min chart. Example of Retracement levels from down thrust.
Down thrust levels - Forex School
Commander in Pips: If you wish, you may check level numbers with manual calculation. Now let’s point out some additional properties of retracement levels:

Properties of retracement levels – as support as resistance

1. Fibonacci retracement could be applied at any time frame;

2. The major ratios and most reliable levels are 0.382 and 0.618;

3. Because of that, they are extremely well-known among traders and market makers. It means that the appearance of a failure breakout, such as Wash and Rinse is very probable there.

4. If some level has been broken by price action – then it should be dropped out from further analysis and you have to not take it in consideration.

5. If th market totally disrespects some obvious and strong level, say, on weekly or monthly time frame – very often the market returns to it and tests it from the other side after breakout;

6. 0.5 level of some long range single up/down candle itself could be a support/resistance level, so as its low/high.

7. We can judge via retracement depth about further market moves. If a retracement was shallow (0.382-0.5) then we can expect a significant further move. If a retracement was deep (0.618-1.0), then any up move could be shallower, or even just back to the previous highs.

8. Levels could be broken - they are just temporary supports or resistances. How it looks like – you can see on chart #1. They are not “Stand forever” substance. If it was so – there will not be any simpler thing, as just to buy or sell from them. Unfortunately this is not the case. That’s why – 

9. Use Fibonacci levels only in combinations with other tools to increase probability to success.

10. It’s better to use levels of higher time frames to trade on lower time frames. For instance to enter long on 60-min chart, it’s better use support levels of daily time frame, etc.

11. The higher the time frame of the swing – the stronger retracement levels from it.

All other properties are the same as non-Fibonacci support and resistance levels:

1. If the market holds above/below the support/resistance level and has not closed below/above it but just insignificantly pierced it (with candle shadows), the more probable that it still valid. So, Close price is your first assistant.

2. To not be trapped with stop licking (i.e. Wash and Rinse) you may act in two ways – place your stop-loss order a bit deeper or wait for the appearance of a Wash and Rinse pattern as a confirmation of the level’s strength and further upward/downward market move. After you will see, that the Stop licking pattern completed – you may enter in corresponding direction.

3. Wash and Rinse is a fast pattern, so if the market has broken a level (i.e. close below/above it) and holds their for 3 periods (i.e. 3 bars/candles) or more, then probably this level has been erased by market action and not valid any more;

4. When price breaks the support level - later it could retest it and this area can act as resistance. The same is true for a resistance level – after breakout, it could act as support if the market will return and retest this area;

5. The more often price tests the level – the weaker it becomes;

6. The longer some level holds, the stronger could be the move after a true breakout of this level;

7. Treat the levels as some area, especially on longer time frames, such as weekly and monthly. The longer your time frame – the wider support/resistance area.

Pipruit: Huh, Commander, so many properties? How could I remember all of them?​

Commander in Pips: And what do you expect from me - sweet toffees? You will have to learn that, if you want to use them not as others do.

Besides, I suspect that you just itching to start advance talks about Fibonacci retracement.

Pipruit: Oh no…​

Commander in Pips: Yeah! Come on, it will be interesting.

Comments

john Garbett
7 years ago,
Registered user
Holding for 3 periods

Hi Sive
You say that if market has broken a level and holds there for 3 periods, then the level is erased, but which timeframe should be used for the 3 periods ... 3 days, 12 hours or 3 hours?

Thanks
John
Sive Morten
7 years ago,
Registered user
> Hi Sive
You say that if market has broken a level and holds there for 3 periods, then the level is erased, but which timeframe should be used for the 3 periods ... 3 days, 12 hours or 3 hours?

Tha..

Hi John,
the same periods, that you use to build/estimate these levels.
shappons
7 years ago,
Registered user
hello sive,
u said in chart 1 the 0.382 is ignored but i saw it a support for many bars near the centre of the chart.

did i miss something?

thanks
shappons
Sive Morten
7 years ago,
Registered user
> hello sive,
u said in chart 1 the 0.382 is ignored but i saw it a support for many bars near the centre of the chart.

did i miss something?

thanks
shappons

Hi Shappons,
Since market has broken through that level previously, it could not be treated as support anymore. But sometimes happens so that market could respect it later.
Unfortunately we can't predict it ahead of time, and this is relatively rare. That's why the best approach is to ignore that level, if it has been broken significantly already, i.e. market has reached next level.
psyguy
7 years ago,
Registered user
Hi Sive (Or someone else if you can answer the question)
On mt4 its seams like the number are reverse.
The lines are place in the right spot but the number does not correspond.
Is this normal?
Thanks in advance.
Sive Morten
7 years ago,
Registered user
> Hi Sive (Or someone else if you can answer the question)
On mt4 its seams like the number are reverse.
The lines are place in the right spot but the number does not correspond.
Is this normal?
Tha..

Hi Psyguy,
what numbers are you particularly speaking about?
Let's me guess, try to draw Fib levels vice versa - if you start to draw from the top, try to start from the bottom. This may be help.
If not, give me more clarification what is wrong with your levels, ok?
Jyotiprakash Pal
7 years ago,
Registered user
Sir Phyguy means this ... if we want top is Mt4 .. and Draw buttom 2 up

161.8 go below :(
forxme
6 years ago,
Registered user
I should ask, how long will the Fib retracement levels hold until another Fib level has to be calculated. Is it after a break through the top Fib level, such as point A or the o level. This is for the upward thrust. Not sure of bottom level thrust. What is the break through level of bottom thrust before new calculation of fib level.
Sive Morten
6 years ago,
Registered user
> I should ask, how long will the Fib retracement levels hold until another Fib level has to be calculated. Is it after a break through the top Fib level, such as point A or the o level. This is for t..

Fib levels should be recalculated when extreme was renewed by price. So, if you calculate support levels from upward swing - recalculate when price creates new high, resistance levels- new lows.
shappons
2 years ago,
Registered user
hello Sive,
quote:
5. The more often price tests the level – the weaker it becomes;

does weaker mean a break thru that retested level has a high probability or the bounce off becomes weaker?

thanks in advance
David Berenyi
2 years ago,
Registered user
Hi Sive,

Did I put the Fibonacci retracement correctly on the attached picture? I understand that the swing high is the latest high. I am just a bit confused when I have to choose the swing low. It is the low before the up move with higher lows on both side, or shall I choose the other low candle on the picture which is the lowest one there but few candles away from the up move.

Thanks for making this website, the most helpful which I could find on the internet. Also thanks for the books you suggest to read, I already have bought " The new science of technical analysis" and planning to buy later all the book you suggest.
Hamza Samiullah
2 years ago,
Registered user
Nice work

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