Fibonacci Retracements: the Magical World of Discounts

8 min read

Elite CurrenSea is presenting to you a grand series of Fibonacci articles and Youtube videosArticle one discussed Fibonacci the person, Fibonacci the sequence and Fibonacci the levels, whereas this post focuses on the retracement levels.

Please be aware that: we are handing out our eBook on Fibonacci for FREE when you send us a simple email to info@elitecurrensea.com.

Check out the video here below to see the video form of this post:

Fibonacci Retracement Basics

Fibonacci retracement levels are ratios which are based on the Fibonacci sequence numbers and have values between 0 and 1 (such as 0.618). In many cases traders also use percentages to describe the ratio (for instance 61.8%). There are 3 main Fibonacci retracement levels:

The 0.618 level OR 61.8%
The 0.500 level OR 50.0% / 50%
The 0.382 level OR 38.2%

The 0.50 level is the exception and is NOT based on Fibonacci sequence numbers. It is still added to the chart because of its value as the half way mark.

The Fibonacci retracements are also called Fib tool and Fib retracement OR plainly Fibs, Fibo or Fibo tool. All of these abbreviations simply refer to Fibonacci and are used to save time and provide variation.

The above retracement levels are considered to be the main ones (more levels are mentioned later on) and are typically always visible when a trader uses the Fibonacci tool. The Fibonacci tool is a charting device that can be used to quickly place the Fibonacci retracement levels on the chart, without any need for completed calculations, by clicking and dragging 1 button. The Fibonacci tool is a great time savior, decreases errors and generally simplifies the usage of Fibs in technical analysis.

Check out this YouTube video for more information on drawing the Fibonacci tool. Generally there are two different ways of placing a Fibonacci tool on the chart. Nenad and I prefer the method which drags the tool from left to right, but there are some who prefer the opposite.

More Fib Retracements

There are more Fibonacci retracement levels than the 3 mentioned above, although some of these levels are calculated differently. Here are the ratios I actually use on my charts. I also explain behind the arrows plus how the levels are derived:

236 or 23.6% – for instance 55 / 233
382 or 38.2% – for instance 55 / 144
500 or 50.0% – half way mark
618 or 61.8% – for instance 55 / 89
786 or 78.6% – square root of 0.618
886 or 88.6% – square root of 0.786

The Fibonacci tool will also show the 0 and 1 (or 0.0 / 100.0 marks). These levels simply indicate the bottom and top.

There are a few other Fibonacci levels that I personally do NOT use but that are occasionally applied by other traders such as:

146 or 14.6% – for instance 55 / 377 (I do not use it)
764 or 76.4% – 100-23.6 (I do not use it)

The 3 main Fibonacci levels are automatically plotted on the chart. Any other Fibonacci level must be added manually. Check out this YouTube video which shows more about the basics like formatting and removing the Fibonacci tool.

Interpreting Fibonacci retracements

Now that you know what the Fibonacci retracement levels are and how are they calculated, let us discuss what they actually mean.

When price reaches one of the Fibonacci retracement levels, this means that price has retraced back to a ‘discounted’ level.

Let us use this example:

EUR/USD moves up from a bottom of 1.0520 to a peak of 1.1470.
Price fails to continue to higher levels.
Price then starts to retrace lower.
Place Fibonacci tool from top to bottom (also called a swing).
Retracement levels are support & bounce spots in an uptrend (in downtrend the levels are resistance bounce spots).
Price can use 1 of the Fib levels to continue back higher (depending on higher time frames and the trend).

The market uses Fibonacci retracements levels because it provides a ‘discount’ within a trend. When a trader sees the EUR/USD move up from 1.0520 to 1.1470, then entering at the 61.8% Fibonacci level basically means that a trader is getting a 61.8% discount compared to the very worst price (the top in this case at 1.1470).

A 50% retracement simply means getting half off (shoppers love this). Simply put, who would not want a discount like that? 😉 The same principle can be used in the world of Forex trading. In the example below there is a trend which stalls and retraces back to 61.8%Fib. Traders are going to use this chance, just like shoppers do.

Why Fib discounts work and when not

The Fibonacci retracement levels are a great method for measuring the market psychology (as shown in example above). The Fibs provide lots of value and work very well because of the psychology in and behind the market place. Traders know that a trend can continue after a pullback to a Fibonacci retracement level and hence the levels are well respected in the market. The traders and the markets gladly accept the discount (within the trend) and use these levels for buying lower and selling higher.

There are 3 important warnings:

1) Pre-requisite: the presence of a trend. There must be a trend and a decent change of trend continuation otherwise the Fibonacci retracement levels will not be used and will have no meaningful impact on price movement (more explained in future article).

2) The Fibonacci retracement tool must be drawn correctly otherwise the levels will not be respected by the market (more explained in future article).

3) Even if the Fibonacci retracement level is drawn correctly, not each and every Fibonacci retracement level will be respected but on average they will work 2 out of 3 times (more explained in future article).

Shallow-deep Fibs

Last but not least, it is important to know the concept of shallow versus deep Fibs. Shallow indicates that price has not retraced very far on the Fibonacci ladder, whereas deep Fibonacci levels have retraced a lot further.

The 23.6% and 38.2% are shallow Fib levels, the 50% and 61.8% are intermediate or medium Fib levels, and the 78.6% and 88.6% Fib levels are known as deep Fib levels.

TOP/BOTTOM: 0% or 0.000
SHALLOW: 23.6% or 0.236
SHALLOW: 38.2% or 0.382
MEDIUM: 50% or 0.500
MEDIUM: 61.8% or 0.618
DEEP: 78.6% or 0.786
DEEP: 88.6% or 0.886
TOP/BOTTOM: 100% or 1.000

When traders can expect a deep or shallow retracement shall will be answered in the next part. Before leaving, make sure to read our entire Fibonacci series!

P.s. Check out the YouTube video if you are interested in seeing the same article in video form.

P.s.2. We are handing out our eBook on Fibonacci for FREE when you send us a simple email to info@elitecurrensea.com.