We all know price most of the time moves in bullish or bearish trends. Inside these trends it normally does long movements (impulses) in the main trend direction, and other shorter movements (retracements) against it. Once the impulse has given signals of ending, we must be aware of a possible retracement. A retracement represents a movement on the opposite direction of the main dominant tendency.
With the use of Fibonacci retracements, we contemplate the possibility of the price coming back a certain percentage of the original movement. It may encounter certain support or resistance levels at Fibonacci numbers. These levels are built by measuring the distance between the beginning and the end of the movement (from minimum to maximum) and applying different percentages to that distance. The most common percentages are: 23,6%, 38,2%, 50%, 61,8%, 76,8% and 100%.
The first time I met this tool I thought it was something esoteric and I didn’t believe in its utility. However, the more I’ve been using it the more I see how useful it is. I firmly think that it’s not magic, it simply works because most of the people use the same levels, so it’s natural that the price reacts at these points. If most of the beginners in the market buy when the price reaches certain level X, it’s almost sure that the price will rise when it reaches that level. We must understand these levels as a kind of support for bullish trends and a resistance for bearish trends. Moreover, if they are coincident with “real” support and resistance levels they become much more important and it’s at that point when we must be very cautious about them. On the following pictures we can see some examples on how the price reacts when it gets to these levels. It’s very common that the price goes back into the dominant trend. However, we must wait to get a clear signal before entering into the market. The price getting to a certain level is never enough reason to enter into the market, as you never know which level the price will reach (it can be any of them).
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Fibonacci is a great tool. When price shows that it has arrived the end of the impulse, it’s strongly recommended to draw it and check at which levels the price might turn in order to make a new impulse again.
As with every other element we use for our analysis, we must look for a convergency. If some of them are against the others, it’s better not to operate. We always must have clear signals in order to enter the market. In the case of Fibonacci Retracements, when the levels are coincident with other global supports/resistances, trendlines, important maximum/minimum levels, etc we must take them very into account. It’s very important that that’s the way we trade. That’s how we can gain the maximum advantage to the market, which is the most valuable thing as Forex traders nowadays.