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The Fibonacci sequence represents a key pattern of numbers and ratios that are found in life. When these are utilised within trading, traders can look for countertrend pullbacks in similar rations. However, the tool provides a whole host of uses, that can enlighten you with powerful trading opportunities within the financial markets.
The Fibonacci tool guides to the degree to which a market moves against the trend, with each retracement level telling you a different story around the mood and sentiment within the market. Markets never move in straight lines, and it is this inability to maintain a constant directional momentum which allows for retracements. The Fibonacci retracement tool should only be used at a time when you believe that the current move is merely a retracement, rather than a reversal. That means that the price is not expected to pass through the 100% mark, instead turning back in the direction of the initial move. The use of Fibonacci levels can be particularly useful if you are a follower of Dow Theory, where a trending market is formed via the creation of higher highs/highs. In such a circumstance, a break past the 100% mark would negate the current trend in play. With that in mind, it makes sense to utilise the swing highs and swing lows that make up a trend for stop loss, and potential take profit targets.
Finding the appropriate levels to draw your Fibonacci from, can take a degree of artistry, with markets typically exhibiting trends within trends to confuse things. Essentially, look for the major turning points in the markets, with specific indecision candles often exhibited at swing highs. Look out for doji and spinning top candles, or more simply, candles with long upper or lower shadows, often turning points in the market.
The difficulty can come where you see smaller swing lows formed within the wider moves. Often, it can be beneficial to switch timeframes, to provide a greater degree of clarity. The shaded circle below highlights how the price broke through what could be perceived as a swing high, only to retrace the wider 76.4% move.