A guide to using the Fibonacci tool to trade

That chart brings together a number of factors. It highlights the formation of swing highs and swing lows, which together provide us with a basis for a trend under Dow Theory. It also highlights the notion that we can often see long legged candles at those crucial turning points in the chart. However, one of the more interesting parts of this chart is that we have seen a series of deep retracements, with four consecutive pullbacks moving into the 76.4% level, before turning lower once more. This brings us to the next point, of differentiating between different Fibonacci levels.

The size of each retracement tells us a lot about the market mentality at any given time. Shallow retracements (23.6%-38.2%) often take place within confident, impulsive market moves, where counterarguments are few and far between. Bitcoin often sees such shallow moves, with confidence currently sky-high. Conversely, a deep retracement (61.8%-76.4%) can take place within a more hesitant period, such as a market reversal or consolidation. Interestingly, the example above showed a market that saw a bullish reversal upon completing a series of deep retracements. The initial wide swings in the market showed that there was enough support for the bullish side of the story, despite the overall trend moving to the downside.

If you look at utilising the previous swing high (for downtrend), or low (for uptrend) for your stop loss, then the depth of a retracement would be another measure of how far your stop loss is from entry. A wider stop loss would require a proportionately larger move in your favour to obtain a high risk-to-reward trade. That being said, a deeper retracement would provide a greater likeliness that the trend is finally going to end, given that this typically takes place in market conditions that are less confident (as mentioned above). The running theme behind the utilisation of the Fibonacci retracement tool, is the notion that a countertrend move is likely to resolve itself with a return to the overarching trend. With that in mind, there are many idiosyncrasies behind the different use cases for Fibonacci. However, while it makes sense to look at the toll as something which can provide ‘support’ and ‘resistance’, in fact it provides much more.