Fibonacci Retracement Levels on Upward and Downward Trend
The price of a currency pair does not move up or down in a straight line. Instead it moves up or down in a zigzag pattern. Fibonacci Retracement is the tool used to calculate where the zigzag will stop. The Retracement levels are 38.2%, 50% and 61.8%, these points form the points at which price is likely to make a pullback and these levels are plotted automatically using the Fibonacci retracement tool that can be found on the MetaTrader 4 trading platform.
What is a retracement? It is a pullback of the price before the market resumes the original trend/original direction of movement.
Example of Zigzag Movement: The Example below shows price moving up in a zigzag pattern.
The diagram below shows movement in an upward Forex trend.
1-2: Price moves up
3-4: Price moves up
5-6: Price moves up
Since we can spot where a retracement starts on a Forex chart, how do we know where it will reach?
The answer is we use Fibonacci retracement tool.
Fibonacci retracement is a type of line study used in currency trading to predict and calculate price pullback levels. The Fibonacci is placed directly on the currency chart within the trading platform provided by your broker, This indicator will then automatically calculate these pullback levels on the chart.
What are The Fibonacci Retracement Levels
- 23.6 %
- 38.2 %
- 50.0 %
- 61.8 %
38.2 % and 50.0 % Levels are the most used and most of the time this is where the price will reach. With 38.2 % being the most popular and most widely used.
61.8% is also commonly used to set stops for trades opened using this strategy.
To calculate these pullbacks on the chart for example the MetaTrader 4 we use retracement levels tool/indicator as shown on the image below.
If you want to analyze some charts using this tool, it is already provided for in the MT4 platform, the following procedure is used to add this tool on the MetaTrader 4 Software. On The MT4 this tool will automatically draw the retracement levels on a chart once it is placed on the the Forex chart.
To add this tool on the MetaTrader 4 software, you can use the following shortcut method:
1. Click Insert
2. Click Fibonacci
3. Click Retracement
How to add Fibonacci Retracement tool on the MetaTrader 4 Software
After adding this tool on the MT4 platform this indicator can then be accessed from "MetaTrader 4 Line Studies Tool Bar" as shown below.
Fibonacci Tool on MetaTrader 4
This tool is located on MetaTrader 4 (Line Studies Toolbar), to go to this toolbar click "View" at the top left corner of MetaTrader 4 next to file, then click "Toolbars", Then Check "Line Studies". You can learn how to use it on the MetaTrader 4 using a demo practice account.
Below is an illustration of the Fibonacci retracement tool, we always plot the indicator between two points, point 1 and point 2, in the direction of the Forex trend as shown below.
How To Place Fibonacci Retracement on a Forex Chart
To Place this tool on a chart, click on the button shown above on the MetaTrader 4 software. Then select 2 chart points, the first point is where the trend starts and the second point is where the trend pull back.
The Fibonacci retracement tool will be drawn in the direction of the trend as explained in the examples below using an upward trend and downward trend example.
How to Draw Fibonacci Retracement Levels on an Upward Forex Trend
In the diagram below the price is moving up between 1 and 2 then after 2 it retraces down to 50.0% pull back area then it continues moving up in the original upward trend. Notice that this indicator is drawn from point 1 to point 2 in the direction of the Forex trend (Upward).
Because we know this is just a price pullback based on our using this retracement indicator, we put a buy order just between the levels 38.2% and 50.0% and our stop loss just below 61.8% pull back mark. If you had put a buy at this point in the trade example below you would have made a lot of pips.
Fibonacci Drawn on Upward Forex Trend
Explanation for the Above Example
Once the trade hit the 50.0 % Retracement, this zone provided a lot of support for the price, and afterwards the market then resumed the original up trend and continued to move up.
23.6 % provides minimum support and is not an ideal place to place an order.
38.2 % provides some support but price in this example continued to retrace up to the 50 % zone.
50.0 % provides a lot of support and in this example, this was the ideal place to place a buy order.
For this example, the price reached the 50.0 % pull back area, but most of the time price will retrace up to 38.2 % and therefore most of the time traders set their buy limit orders at the 38.2 % level, while at the same time placing a stop just below 61.8 %.
How to Draw Fibonacci Retracement on a Downward Forex Trend
In the diagram below the price is moving down between 1 and 2, then after 2 it retraces up to 38.2% retracement then it continues moving down in the original downward trend. Notice that this indicator is drawn from point 1 to point 2 in the direction of the Forex trend (Downward).
Because we know this is just a pullback we put a sell order at 38.2% level and a stop loss just above 61.8%.
If you had put sell order at the 38.2 % level as shown on the trade below you would have made a lot of pips afterwards. In this trade the retracement reached 38.2% point and did not get to 50.0% mark. From experience it is always good to use 38.2% because most times the price pullback does not always get to 50.0% mark.
Fibonacci Tool Drawn on Downward Forex Trend
Explanation for the Above Example
The above example is the perfect setup for Fibonacci Forex Trading, where the price retraces immediately after touching the 38.2 % Level.
This zone provided a lot of resistance for the price pull back, this was the best place for a trader to place a sell limit order.
The same Fibonacci Analysis can also be applied in Stocks trading and commodities trading such as trading of Silver and Gold commodities.
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