Using Fibonacci Retracement In Order To Enter A Trade

The Fibonacci tool works at its best whenever the market is trending, either up or down. The aim is to buy on a retracement at a Fibonacci support level when the market is trending up, and obviously to sell on a retracement at a Fibonacci resistance level when the market is trending down.

Now, you need to find the recent Swing Highs and Swing Lows. If it’s an uptrend, you click your cursor on the Swing Low and drag it to the most recent Swing High. For the downtrend, you just do the opposite of course: click on the Swing High and drag to the most recent Swing Low.

Let’s have a look at how to do this.

Here is a chart of the AUD/USD.

Chart goes here

What happened is that we clicked on the Swing Low at .6955 which occurred on April 20th, and dragged the cursor to the Swing High at .8264 of June 3rd. As you can see, the software shows the retracement levels, which were as follows:

.7955 (23.6%), .7764 (38.2%), .7609 (50.0%), .7454 (61.8%), and .7263 (76.4%).

What we expect to happen is that if the currency pair retraces from the high, then there will be support at one of these Fibonacci retracement levels, because many other traders will place buy orders as the price pulls back.

What actually happened after the Swing High occurred was as follows.

Chart goes here

The 38.2% level held as the support level. The price pulled back through the 23.6% level and carried on downwards for another fortnight or so. It actually tested the 38.2% level, but did not close below it. Around about the middle of July, the market returned to its move upward, and eventually broke through the Swing High. Obviously, buying at the 38.2% level would have shown a decent profit.

Next, we want to discover how to use the Fibonacci retracement tool in a downtrend. Here is a 4 hour chart of EUR.USD.

Chart goes here

The Swing High was found at 1.4195 on the 25th of January, and the Swing Low a week later on 1st February. The retracement levels are as follows: 1.3933 (23.6%), 1.3983 (38.2%), 1.4023 (50.0%), 1.4064 (61.8%) and 1.4114 (76.4%).

Now if the price retraces from as low as this you might expect that there could be a resistance at one of the Fibonacci levels. The reason for this is that traders who want to play the downtrend might well be prepared with sell orders. What actually happened is as follows:

Chart goes here

As you can see, the market tried to rally, and stalled below the 38.2% level for a while, then tested the 50% level. If you had had orders at either of these levels, you would have made a lot of very nice profit.

There are so many people who use the Fibonacci tool that the retracement levels become self-fulfilling prophecies. The price found some resistance, but only temporary, at those Fibonacci retracement levels.

However, it is important to note that the price will not always bounce from these levels. They are really areas that should be of interest, but the price reaction is not cast in stone.

Just remember that the Fibonacci tool is not always as easy to use as it might look. If it was that easy, everyone would place orders at the retracement levels. In fact, in the next lesson you are going to see what happens when the Fibonacci retracement levels don’t work as you want them to.