The Fibonacci retracement is a subjective trading tool, but there are ways traders can use its odds in their favour.
Even though the Fibonacci retracement tool is extremely effective, it’s not advisable to use it independently on a trading chart. Professional traders combine it with other tools to make profitable trades.
A great way to use the Fibonacci tool to find profitable trade setups is by combining it with support and resistance lines.
Combining the Fibonacci tool with support and resistance lines
The Fibonacci retracement is popular with traders because it’s one of the best tools for spotting potential support and resistance levels.
Should the Fibonacci retracement levels align with the support and resistance levels that a trader draws, the market price will respect the levels. In such cases, there’s a high chance that price will bounce from those levels.
Below is a USD/CHF chart on a one-hour time frame showing how the Fibonacci retracement tool lines up with support and resistance pivot
On this USD/CHF chart, we can see the reaction of price on the Fibonacci retracement levels.
This Fibonacci retracement has its plotting on the highest swing high of 0.99732 and the lowest swing low of 0.96916 price action.
In this scenario, we can see the USD dropping rapidly against the Swiss franc from the 31stJuly 2019 to the first week of August 2019. The dollar dropped dramatically due to the interest rate cut announced by US Federal Reserve.
After the US Fed made the announcement, the US dollar began to weaken against the Swiss franc, which led to a strong trend formation.
However, at 0.96916, the US dollar became oversold, and the bulls took over the market for some time. Price reaction at that level produced slight support that pushed price upwards.
Also, we see the Fibonacci retracement tool aligning with all the support and resistance pivot points used in creating the lines in the chart.
Therefore, a trader who entered a buy or sell position when price touched the different Fibonacci levels would profit.
The challenge is finding the right point to enter a trade as price touches the support/resistance lines and the Fibonacci levels.
How to spot a good entry point with the Fibonacci tool and support/resistance levels
One attribute that makes traders successful is their ability to spot good entry and exit points. This determines the level of profit or loss traders earn in the market.
Combining a Fibonacci retracement tool with support and resistance lines can enable a trader to spot good entry and exit points.
In trading, past trends usually forecast the present and future trends. Price always reacts in the future at roughly the same levels it reacted in the past.
With nicely drawn support/resistance lines, a trader can forecast the possible direction of price action. Adding the Fibonacci tool gives more confirmation.
Below is a USD/JPY chart showing price reaction on the Fibonacci retracement tool and support/resistance line
In the chart above, we can see a great example of the Fibonacci retracement tool combining with support/resistance lines to provide good entries to take short-term trades.
At the 107.865 level, there was strong resistance in the first week of July, from the 2nd to 4th, until price broke through it. It later became a support level from the 10th to 17th of the same month.
The Fibonacci tool drawn on the chart provided a great confirmation for traders to enter a buy position at the 0.0% level while setting a stop loss a few pips below, in line with the last pivot point.
At the 23.6% level, the trader can take small profits of 20 pips, or they can hold the position until the price reaches 38.2% and close the buy trade.
The 38.2% level was a good support line in the past. The combination of the retracement tool and the support line made things clearer for the trader.
Because price broke the support level previously at least twice, the level became a strong resistance level. Therefore, the level became a great entry point for a trader to open a sell position and hold for a day or longer to make huge profits.
Summing it up
- Preceding support or resistance levels are great areas to open buy or sell positions because other traders are eyeing the levels.
- Many traders use the Fibonacci retracement tool to jump into trades.
- There are usually a lot of orders on the support/resistance levels.
The bottom line
Traders can be more confident about opening buy or sell positions at support/resistance levels combined with Fibonacci levels, even though there’s no guarantee that price will always bounce from those levels. After all, there is power in numbers.
Most importantly, trading is all about probabilities. Traders who stick to higher-probability trades always have a better chance of becoming more successful over time.