This post is written by Jet Toyco, a trader and trading coach.
Here’s the reality…
The Fibonacci retracement is probably the most popular trading tools on the market.
At the identical time…
It’s also probably the most debated ones.
It makes people wonder:
Does the Fibonacci retracement work?
Does it have an edge within the markets?
Should I even carry on using it?
You see my friend…
What makes a superb swordsman is just not his sword.
However the skill he has to wield the sword.
It’s the identical for trading tools resembling plotting support and resistance
Plotting trend lines.
And at last, drawing Fibonacci retracements.
So, the query now could be…
How do you draw a Fibonacci retracement?
Can we start plotting by including the wick?
Or can we plot from the body?
Well, consider me…
The reply isn’t so simple as it seems as we’re only taking a look at the tip of the iceberg here.
For this reason on this guide you’ll learn:
- An in-depth but quick explanation as to how the Fibonacci is applied in trading
- What you need to NOT do drawing the Fibonacci retracement
- A fool-proof and step-by-step guide on plotting the Fibonacci retracement
That’s right.
You’ll be getting the entire package here.
So, get your notes up, and let’s start!
What’s Fibonacci Retracement and How Does It Work?
In case you didn’t know…
The Fibonacci levels you see in your chart should not the Fibonacci sequence itself.
You is perhaps pondering:
“Wait what?”
“So, where did those numbers come from?”
Good.
You’re asking the correct questions!
So, let me inform you where those numbers come from.
Now, the unique Fibonacci sequence is as follows:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377
Again.
How on earth did those numbers come into place?
You’d be surprised, basic math!
See?
It’s just about only a mathematical “sequence” where you add the previous number to get the subsequent one!
But so simple as it’s…
The Fibonacci is throughout nature!
From architecture…
To animals…
Even to humans!
Alright, we’re getting side-tracked here…
So!
How does it apply to trading?
How on the earth did we freaking get these Fibonacci ratios in trading?
23.6%, 38.2%, 50%, 61.8%, 88.6%
So, remember how we get the subsequent number within the Fibonacci sequence by adding the previous one?
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377
On this case, we’re using this same Fibonacci sequence to divide them in order that we will get the Fibonacci “ratio.”
Let me provide you with an example…
In case you divide 21 by 34 within the Fibonacci sequence, what do you get?
0.618 (61.8%)
Now, what in case you divide 21 by 55 which is 2 sequences away?
0.382 (38.2%)
How about 21 with 89 which is three sequences away?
0.236 (23.6%)
That makes more sense, right?
I mean, we’d like to learn how one can apply these to financial markets!
And as you realize…
It’s this exact same Fibonacci ratio that we learn how one can draw Fibonacci retracement in very alternative ways.
Reminiscent of with the Fibonacci circle:
Fibonacci fan:
And at last, which is what we’re going to give attention to today, the Fibonacci retracement:
Now before we go head-on as to how one can draw Fibonacci retracement…
Let me inform you a typical mistake a trader makes when plotting them on the chart.
Essentially the most common mistake traders make when knowing how one can draw Fibonacci retracement
You see…
Knowing how one can draw Fibonacci retracement is greater than just knowing whether or not you need to “include” the wick or the close.
It’s about identifying your market structure and condition!
For this reason traders often make the error of not learning…
discover relevant swing highs and lows properly
Plotting a Fibonacci retracement requires two things.
A swing high, and a swing low:
That is so that you would be able to determine how low the pullback can potentially go:
That is smart, right?
Nonetheless…
How about these swing highs?
Aha, that is where things can get tricky.
Because numerous traders can get confused about whether or not they need to plot their Fibonacci retracement like this:
Or like this:
Which swing high do you have to start drawing your Fibonacci retracement?
Now in case you’re in this example, what do you do?
Yep, you most likely find yourself plotting more Fibonacci retracements in your chart:
But this my friend…
Is the flawed approach to use this tool.
Yes, plotting more Fibonacci retracements can provide you with “confluence” on which levels to have a look at:
But it will do you more evaluation paralysis than actually making good trades.
So?
What’s the answer?
Deal with the present price, and the relevant swing highs and lows for that current price
As a Fibonacci trader myself before…
I fell into this trap of plotting each Fibonacci retracement I can plot on and zooming out my charts so far as I can.
However the moment I focused on the present price:
After which determining the “relevant” swing highs and swing lows:
Identifying trading setups has been clearer than ever:
That’s right!
Less is more, my friend.
One good Fibonacci retracement is all you wish more often than not!
And this leads us to the principal query of the day…
“ draw Fibonacci retracement properly?”
Let me show you in the subsequent section…
A Step-by-Step Guide on Draw Fibonacci Retracement
Let’s get right into it, lets?
Now listen fastidiously…
To consistently draw a Fibonacci retracement, these are the steps that you could be mindful:
- Discover the market condition
- Discover the relevant swing highs and lows
- Plot your Fibonacci retracement that coincides with the market condition
Let me show you ways it’s done!
1. Discover the market condition
This part is crucial as you don’t need to be plotting the Fibonacci retracement into the wild.
Because in case you remember…
Our purpose in knowing how one can draw Fibonacci retracement is to gauge how deep a pullback can go in an existing trend!
So, you could discover whether the market is in an uptrend:
Or in a downtrend:
P.S. To maintain things objective, you should use the 200-period moving average to define market conditions with ease.
Next…
2. Discover the relevant swing highs and lows
Remember what we talked about within the last section?
Good.
As you need to give attention to the present price and determine the relevant “leg” or swing highs and lows based on the present price.
Here’s an example in an uptrend:
And in a downtrend:
Is smart?
So now that you’ve got your relevant swing highs and lows…
All that’s left is to attract your Fibonacci retracement!
3. Plot your Fibonacci retracement that coincides with the market condition
The explanation why I shared with you those two prior steps is that this…
It’s so that you simply don’t plot your Fibonacci retracement the other way up!
That’s why in an uptrend, you could plot your Fibonacci retracement from the swing low up until the swing high:
And in a downtrend, you plot the Fibonacci retracement from the swing high right down to the swing low:
So, are you able to see how vital it’s to discover the trend first?
Because remember…
We try to measure how deep a pullback can potentially go, before it potentially reverses.
Here’s an example from USDMXN Every day chart:
One other example from Wheat Futures Every day chart:
And there you go!
A step-by-step guide on how one can draw Fibonacci retracement!
But wait, I almost forgot something!
There’s still yet another query left I forgot to reply…
Do you begin plotting from the wicks or the close?
I’ll be honest with you…
This is commonly an issue I get about drawing Fibonacci retracement!
But for the sake of consistency…
I suggest plotting from wick to wick.
The one exception is when the wick becomes too volatile or becomes an “outlier” to the market structure:
In that case…
I exclude that wick and begin plotting at the realm where the swing high or low is relevant and visual:
P.S. I plotted my Fibonacci retracement two swing lows below because it is more relevant to the present price
Sounds good?
Then start going into charts and begin practicing how one can draw Fibonacci retracement!
But nonetheless…
In case you want to take things to the subsequent level by learning how one can benefit from this tool, I highly suggest you check this out:
The Essential Guide To Fibonacci Trading
With that said, let’s have a fast recap of what you’ve learned today…
Conclusion
When used right…
The Fibonacci retracement is a strong tool that may provide you with an objective view of how one can trade pullbacks and “predict” reversals.
But in point of fact, learning how one can draw Fibonacci retracement requires a process.
That’s why in today’s guide I used to be in a position to share with you that:
- Fibonacci “ratios” are derived from dividing the values from the unique Fibonacci “sequence”
- Plotting the Fibonacci retracement must be kept easy by simply identifying relevant swing highs and lows based on the present price
- Drawing the Fibonacci retracement implies that you could discover the market condition and the relevant swing highs and lows so that you simply’ll know the correct orientation on where you need to plot on a regular basis
And there you go!
So, over to you…
Have you ever been using other tools resembling the Fibonacci extension or fan apart from the Fibonacci retracement?
How is it helping you in your trading immediately?
Let me know within the comments below!