A Fibonacci retracement level is a horizontal line that shows where reversals are likely to occur during a retracement. Fibonacci levels are derived from the “Fibonacci ratios” discovered by the mathematician Leonardo Pisano Bogollo, who was known by the nickname “Fibonacci.” Fibonacci levels can often be used successfully as entry or exit points in trades.
What is the Fibonacci Sequence and Fibonacci ratios?
The Fibonacci sequence begins with zero and one. After zero and one, each successive number is the sum of the previous two. The first ten numbers in the sequence are 0, 1, 1, 2, 3, 5, 8, 13, 21, and 34. A Fibonacci ratio is derived by dividing one number in the sequence with a number that follows it by a certain number of places.
For example, if any number in the Fibonacci Sequence is divided by the following number, it results in approximately 0.618 (61.8%). The higher the two numbers get, the closer they get to 0.618. For example, 3 / 5 = 0.6, 5 / 8 = 0.625, and 13/21 = 0.61764 rounded to four decimal places. For this reason, 61.8% is considered to be a Fibonacci ratio.
Similarly, any number in the sequence divided by the number two places higher results in approximately 0.382 (38.2%). So 38.2% is considered to be a Fibonacci ratio. 23.6% is another example. It is the approximate result of one number in the sequence divided by the number three places higher.
Fibonacci level example
A Fibonacci level is a horizontal line that is 61.8%, 38.2%, 23.6%, or some other Fibonacci ratio distance away from a significant high or low. For example, consider this chart of USD/CHF.
In the chart, USD/CHF has peaked at around 0.998 and gone into a steep downtrend. It has then paused at 0.987. The 61.8% Fibonacci level of this downtrend line is approx. 0.994, the 38.2% level is around 0.991, and the 23.6% level is approx. 0.989. If a counter-trend rally occurs here, we should expect the price to pause or even reverse as it hits these levels. For this reason, a trader who wants to enter a long trade could use these levels as possible take-profit points. A trader could also wait until the price reaches one of these levels and use it as an entry point.
How to draw Fibonacci levels
To draw Fibonacci levels for a downtrend, first find a significant peak in price. Then, click and drag until you reach the trough in the downtrend. When you reach the trough, release the mouse button. For an uptrend, do the reverse: click and drag from the trough to the peak, then release.
How to use Fibonacci levels with other indicators
Like other Forex tools, Fibonacci levels are not 100% accurate. But their accuracy can be improved by combining them with other indicators. Here are two examples of other Forex tools that can be combined with them.
- With support and resistance – When a Fibonacci level is also a line of support or resistance, this provides stronger confirmation that the line will hold. 110.206 and 109.909 in the following chart are examples of this.
- With trendlines – When a trendline crosses a Fibonacci level, this provides further confirmation that a reversal could occur in this area. The white circles on this chart at 38.2% and 23.6% can serve as examples
The Fibonacci retracement tool indicates price levels that correspond to Fibonacci ratios. These are areas where retracements are likely to come to an end as the dominant trend reasserts itself. For this reason, Fibonacci levels can be a useful tool for traders to find profitable opportunities.