What is Fibonacci retracement?

What it is

Fibonacci retracement is a tool that marks potential support and resistance levels where a price pullback might end before the trend resumes. After a strong move, price rarely continues in a straight line; it pulls back part of the way first. Fibonacci retracement estimates how far that pullback might go, drawing horizontal lines at set percentages of the prior move.

The percentages come from the Fibonacci number sequence, a mathematical series that appears throughout nature. Whether markets respect them for any deep reason is debatable, but the levels are watched so widely that they often behave as real support and resistance, partly because so many traders act on them at once.

Disclosure: SatoshiMacro may earn a commission if you open a broker account through links on this page, at no extra cost to you. See our full affiliate disclosure.

The levels

The key retracement levels are 23.6, 38.2, 50, 61.8 and 78.6 percent. The 38.2, 50 and 61.8 percent levels matter most, with 61.8 percent, the golden ratio, the most significant. The 38.2 to 61.8 percent band is often called the golden zone.

The 50 percent level is not strictly a Fibonacci number, but it is included by convention because markets so often retrace about half of a move.

The others all come from the same ratio. Divide any number in the Fibonacci sequence by the next one and you get close to 0.618. Square it and you get 0.382, cube it and you get 0.236, and its square root is 0.786. So 23.6, 38.2, 61.8 and 78.6 are one idea expressed four ways, and 50 is the odd one out.

How to draw it

You anchor the tool between two points, a clear swing low and swing high:

• In an uptrend, anchor from the swing low to the swing high. The levels plot below the high, showing where a pullback might find support.
• In a downtrend, anchor from the swing high to the swing low. The levels show where a bounce might find resistance.

The whole tool is only as good as the swings you choose, so pick obvious, significant turning points that other traders would also see. Most platforms have the Fibonacci tool built in; the skill is in the selection of the anchors, not the drawing.

1. Click the swing low. Here AUD/USD bottoms at 0.6500 before a clean rally.
2. Drag to the swing high. The rally tops at 0.6700, a 200-pip move. The tool now plots each level as the high minus that share of the move.

The arithmetic is simple enough to check by hand: 61.8 percent of 200 pips is about 124 pips, so the 61.8 level sits at 0.6700 minus 0.0124, or 0.6576. The 50 percent level is 0.6600 and the 38.2 percent level is 0.6624. If your platform shows different numbers, you anchored to different candles.

How traders use it

The standard use is timing an entry within a trend. After an impulse move, a trader waits for price to pull back into the golden zone (38.2 to 61.8 percent) and looks for a confirmation signal there to enter in the direction of the trend, with a stop just beyond the next level.

1. Price pulls back to 61.8 percent. It trades down to 0.6571, a few pips through the 0.6576 level. Levels are zones, not exact prices.
2. A bullish engulfing candle confirms. The entry is a buy stop just above its high at 0.6610. The stop goes below the 78.6 percent level at 0.6538, so the risk is 72 pips.
3. Targets. The swing high at 0.6700 is 90 pips away, about 1.25 times the risk. The 127.2 percent extension at 0.6754 is 144 pips, 2 times the risk.

Doing that arithmetic before the entry is the point. If the first target is less than the risk, I pass on the trade, however good the candle looks.

Confluence: when two methods agree

Its real power is confluence. A Fibonacci level on its own is weak; a Fibonacci level that lines up with existing support or resistance, a trendline, or a moving average is far stronger, because several methods point to the same price. That stacking of signals, confirmed by a candlestick reversal, is how Fibonacci earns its place.

1. Old resistance forms. Price stalls at 0.6600 three times. Sellers are clearly sitting there, and it is a round number too.
2. The breakout. Price clears 0.6600 and runs to 0.6700. Old resistance often turns into support once it breaks.
3. The pullback lands on both. The 50 percent retracement of the 0.6500 to 0.6700 swing is exactly 0.6600. Two independent reasons for buyers to show up at one price is the kind of level I would actually trade.

Extensions for targets

Retracements tell you where a pullback might end. Extensions answer the next question: if the trend resumes, where might it run to? The two standard extension levels are 127.2 and 161.8 percent of the original swing, measured from the swing low, which puts them above the swing high in an uptrend.

1. The pullback holds the 61.8 percent level. The trend is still intact.
2. First target, 127.2 percent at 0.6754. That is 0.6500 plus 1.272 times the 200-pip swing. A sensible place to take partial profit.
3. Second target, 161.8 percent at 0.6824. That is 0.6500 plus 1.618 times the swing. The remainder of the position comes off here or trails a stop behind it.

Platforms label extensions differently. Some show them as 1.272 and 1.618, some as negative retracements (-27.2 and -61.8), and on some the direction you drag the tool decides where they appear. Check the price the platform prints, not only the label.

Free Fibonacci retracement cheat sheet

The whole page on one printable A4 sheet: how to draw the tool, the levels with where each ratio comes from and the AUD/USD example prices, labelled diagrams of the 61.8 percent pullback, confluence and extensions, a signals table, five rules of thumb and the three mistakes I see most often.

Common mistakes

The usual Fibonacci errors:

• Anchoring to unclear swings. Vague or cherry-picked swing points produce meaningless levels. Use obvious turning points.
• Treating levels as guarantees. They mark where a pullback might end, not where it must. Wait for confirmation.
• Using it in isolation. Fibonacci is a confluence tool. On its own, it is just lines on a chart.
• Ignoring risk management. A stop and proper position size protect the account when a level fails, which it regularly will.

Used as confluence and confirmed by price, Fibonacci retracement is a useful way to time entries within a trend. Build the rest of the foundation with support and resistance, moving averages and forex trading strategies, and choose a broker with full charting from the best forex brokers in Australia ranking.

Frequently asked questions