Fibonacci Retracement in Trading: A Practical Guide for Analysts

Fibonacci Retracements are one of the most popular technical analysis tools in financial markets. Based on a sequence discovered by Leonardo Fibonacci back in 1170, these mathematical ratios help traders predict levels where an asset’s price may pause during a correction. The most commonly used levels are 23.6%, 38.2%, 50%, 61.8%, and 78.6%, which serve as support and resistance levels on charts.

Origin and Key Fibonacci Retracement Levels

The Fibonacci sequence is based on a simple mathematical principle: each number is the sum of the two preceding ones (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144). An interesting fact is that each number is approximately 1.618 times larger than the previous one. This ratio underpins the golden ratio, which appears in nature and is recognized by markets.

Fibonacci retracement levels are calculated by dividing numbers in this sequence. For example, the 61.8% level is obtained by dividing 21 by 34 or 55 by 89. These levels are displayed on charts as horizontal lines representing critical points where prices often reverse before continuing the main trend.

How to Use Fibonacci Retracements to Identify Levels

In practice, Fibonacci retracements act as a kind of map for traders. When an asset moves upward and then begins to correct downward, a trader draws the tool from the high point to the low point, and the platform automatically highlights key levels. If the price drops to the 38.2% level, it often indicates a minor correction, while a fall to 61.8% signals a more significant pullback.

This approach helps establish entry points, place stop-loss orders at safe levels, and set profit targets. Most professional traders analyze daily (1D) charts to identify long-term trends, as they provide the most reliable signals.

Practical Application of Ratios on Charts

Applying Fibonacci retracements is quite intuitive. A technical analyst identifies two extreme points of movement — a local maximum and minimum. Then, the tool automatically draws horizontal lines at each key level. These lines indicate where the price is most likely to pause before continuing in the primary direction.

It’s important to understand that Fibonacci levels reflect the collective behavior of many traders using the same tool. When a significant number of market participants focus on the same ratios, it creates a self-fulfilling prophecy — the price will indeed react at these levels.

Optimal Settings and Combining with Other Indicators

Different traders may prefer different ratios depending on the asset and timeframe. However, the classic set (23.6%, 38.2%, 50%, 61.8%, 78.6%) remains the most versatile and reliable. Some analysts also include the 50% level, even though it’s not part of the original sequence — it serves as a psychological midpoint.

While Fibonacci retracements are a powerful tool, they have obvious limitations. First, the indicator is subjective — results depend on the choice of extreme points, which can vary among analysts. Second, there is no mathematical proof of their effectiveness, so their success largely depends on widespread market use.

That’s why professionals recommend combining Fibonacci levels with other technical indicators to confirm signals. Popular options include the Relative Strength Index (RSI) to identify overbought/oversold conditions, MACD to confirm trend changes, On-Balance Volume (OBV) for volume analysis, and the Stochastic Oscillator for entry synchronization. This comprehensive approach significantly increases the reliability of trading strategies and reduces false signals.