Fibonacci retracement levels are a useful tool for determining market context and spotting important pivot zones (places where price is likely to encounter support or resistance). By themselves, you probably won’t find these retracement levels all that useful, but in combination with other indicators or price analysis, you may find them very helpful.
What are Fibonacci retracement levels? A mathematician named Leonardo Fibonnaci once discovered a set of numbers that as a series described ratios which are found in nature. The series starts out: 0, 1, 1, 2, 3, 5, 8, 13 …
It is generated as follows:
0+1 = 1. 1+1 = 2. 1+2 = 3. 2+3= 5. 3+5 = 8. 5+8 = 13, and so on and so forth. If you take the ratio of any number to the number which follows it, you calculate .618, while the ratios of alternating numbers in the sequence is always .382. There are a number of these ratios, and these ratios have given us the “Fibonacci Retracement Levels” and “Fibonacci Extension Levels.” They read as follows:
Fibonacci Retracement Levels
0.236, 0.382, 0.500, 0.618, 0.764
Fibonacci Extension Levels
0, 0.382, 0.618, 1.000, 1.382, 1.618
Thankfully that is really all that you need to learn about mathematics in order to use these levels. In fact, you do not really need to know that much, but it is nice to know where things came from that you are going to be using. There may be nothing inherently special about these numbers where the market is concerned, but since these numbers are deemed important, traders tend to watch the retracement and extension levels and behave strangely around them. It is a kind of self-fulfilling prophecy.
Now that you know what the levels are, you need to know how to plot them on your charting software. You do have charting software, right? If not, click here. You will find a list of free platforms which are great for practicing trading.
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To plot a Fibonacci level, you need to look for several things:
A trending market. These levels are not as useful in ranging markets.
A Swing High and Swing Low. Since you are looking at the past, these should not be too hard to identify. Look for a spot where the market peaked and another spot where it hit a trough.
Now, select the Fibonacci tool in your trading platform, and simply click on a Swing High or Low and drag your cursor to the nearest Swing High or Swing Low. If you can see multiple Swing Highs and Swing Lows on your screen, you can even plot the lines multiple times. If you find confluence between the lines (this is where they stack up on top of each other), you are looking at an even stronger area of support or resistance. Price will often hesitate around these levels.
Why Are They Called “Retracement” levels?
Fibonacci retracement levels are called what they are because they are generally used to look for retracements. For example, let’s say that you plotted retracement levels in an uptrending market by drawing your cursor from the nearest Swing Low to the nearest Swing High. The retracement levels will be plotted across your chart.
Since you are in an uptrending market, you are expecting price to continue its uptrend. But you know how price makes little dips along the way as it moves upward, even in a strong trend? These little dips are called retracements. Price often retraces off of the Fibonacci retracement levels and then continues along its way. In other words, price kind of “bounces” off of those levels. In our uptrending market, the retracement levels act as support.
Combining Fibonacci Retracement Levels and Price Action: An Example
So how do you actually use Fibonacci Retracement levels in your trading? One example might be to try combining Fibonacci levels with price action. When you do price action, you are searching for patterns of bars or candlesticks that produce predictable results. These patterns are best combined with Fibonacci levels or other forms of confluence. The price patterns are actually confirmations—triggers telling you that you have properly analyzed the market and it is time to act.
Let us say that in an uptrending market, you plotted Fibonacci retracement levels as described above. Price retraces downward, and on one of the retracement levels, a pattern forms—two bars which share a double low, the second of which has a higher close. The double low indicates that the retracement level was tested twice, and that support held firmly in both cases. The higher close indicates that price is eager to move upward. This would be a great time to buy, since it confirms a continuation of the trend. You have confluence—the price action and the retracement level acting together to tell you it is time to buy. You probably have correctly determined what direction the market is moving in, and that means it is time to buy your option.
Now you have yet another tool in your trading toolbox—two tools, if you also take the time to read our articles about price action and learn to identify bar patterns. Always test your new techniques out before you invest real money. When you test and take time to learn how to trade using reliable, proven techniques, you set yourself up to win with binary options.