Fibonacci Retracements – Complete Strategy Guide

A Fibonacci Retracement (Fib Retracement) is a popular tool used by technical analysts to find potential support and resistance levels. Fib retracements are great for determining where to enter a position, place stop losses, and define profit targets.

They work across all markets including Stocks, Futures, Options, Forex, and Crypto.

In the following guide I’m going to teach you how to use the fib indicator as well as several fibonacci trading strategies you can add to your playbook. Let’s get into it!

What is a Fibonacci Retracement?

The ratio was founded by mathematician Leonardo Pisano, nicknamed Fibonacci. Leonardo discovered a series of numbers that created ratios found to exist repeatedly in the natural environment and the universe.

The series is derived by starting with 0 followed by 1 and then adding a number and the number to its left to get the third number. Each consecutive number is approximately 1.618 times greater than the preceding number.

This calculation generates the following sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377 extending to infinity.

After the first few numbers in the sequence if you dived a number by the next number in the sequence you get .618. For example, 34 divided by 55 equals .618.

If you measure the ratio between alternate numbers you will get .382. For example, 21 divided by 55 equals .382.

Both the 382 and 618 are popular fib levels, but more on that shortly. You can search and read all about these ratios existing in nature, but for our purposes this is enough.

Why do the fibonacci ratios work in trading? Could it be some magical ratio that exists in the markets?

Ultimately it doesn’t really matter but I believe it’s the simple that enough traders use fib retracements that patterns develop, just like any other pattern in the market.

Fib Retracement Levels

The most popular fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 78.6%.

The 50% retracement level (halfway back) is not derived from a fibonacci ratio. However, it is commonly used and was made popular by Charles Dow, founder of Dow Theory.

I’m including it in this guide because it’s probably the most referenced level. One of the startegies you’re going to learn in this guide focuses on the 50% level.

Fib levels tend to work best after a significant move in a trending market. As price begins to retrace, fib levels tend to form support (bullish trends) or resistance (bearish trends).

Next, let’s take a look at how to draw these levels with the fibonacci retracement tool.

How to Draw Fib Lines

Virtually every trading platform these days has a fibonacci tool. If you’re not sure where it’s located do a simply google search. Ex. “tradingview fibonacci retracement tool”

The first step is to identify the most recent swing high and low. Let’s do a quick refresher on swings to make sure you’re identifying them properly.

A swing high (SH) forms when price reaches a new high relative to any preceding highs. Once price moves above a swing high and begins to retrace a new swing high has formed.

A swing low (SL) forms price reaches a new low relative to any preceding lows. Once price moves below a swing low and begins to retrace a new swing low has formed.

When price is making higher highs followed by higher lows a market is considered to be in an uptrend.

When price is making lower lows followed by lower highs a market is considered to be in a downtrend.

After you have identified the most recent swing high and swing low you’re going to select your Fib Retracement Tool.

In an uptrend you select the swing low and drag the cursor to the swing high.

In a downtrend you select the swing high and drag the cursor to the swing low.

The result should look something like the chart above.

The fib tool will be a little different on every charting platform.

You will have to go into the indicator settings and define what fib levels you want displayed and their corresponding colors.

Fibonacci Extensions

Fibonacci extensions are derived from the same sequence of numbers as retracements.

They’re extremely useful to use when setting your take profit or trying to determine how far a bounce may go.

We’re going to be using them along with retracements in the strategies we’re about to discuss, so let’s cover the basics quick.

Select your fibonacci extension tool and select the swing low (1). Next, drag the cursor to the swing high (2), and finally down to the retracement low (3).

Now your tool will plot the fib extensions on your chart that begin from the retracement low (3) as seen above.

In a down trend it’s just the opposite, point 1 would be at the swing high.

The most popular fib extension levels are: 61.8%, 100%, 123.6%, 161.8%

Fibonacci Retracement Trading Strategies

Now let’s get into the fun part, fib retracement strategies.

The final strategy on the list is a full blow strategy on its own. The first three you can incorporate to improve upon your current strategies.

1. Retracements for Building Context

New traders typically fail at building context around their trades. When you apply context you’re essentially defining the market conditions that have to be present to trade that pattern/signal.

Once you begin building context around your setups you actually have what I would define as a trading strategy.

I use fib retarcements to define key support and resistance levels every morning pre-market.

Now that doesn’t mean I will go blindly long or short at these levels. It means that if I see a setup from my playbook at one of these levels I’m going take it and be cognizant that it could be a big reversal and become more aggressive on my take profit.

Let’s look at an example.

The charts of the eMini Nasdaq 100 below has a fib retracement draw from the swing low that occured in March 2020 during the onset of the covid pandemic to the swing high in November 2021 (All time highs).

The the Nasdaq was down over 25% in 6 months. On the morning of May 12th while reviewing my S&R levels premarket I notated that the 11,700 level was the major 50% retracement level.

You can see on the daily chart on the right that we bounced right off the 50% retracement level on May 12th and had a massive rally the next few days.

In the opening 30 minutes on May 12th we dropped and tested the 11,700 level but it was rejected and the market began to rally. I took a long setup shortly thereafter and the market had a vicious rally of over 400 points in an hour.

Later on price sold off always the way back to the 11,700 level and once again was rejected. I ended up taking another smaller position which I held overnight.

Had I only been focused on my shorter scalping time frames, I would never had known that the trade had the potential for that big of a move.

I most likely would have exited a lot earlier and missed out on the easy money.

You can use FIB levels to build context with any trading strategy. I only focus on 50% retracements but should you decide to use fibonacci your trading make sure to try out more of the key levels discussed earlier.

2. ABCD Patterns

An ABCD patter has two equidistant legs “AB” & “CD”. It’s a harmonic pattern that traders use to determine take profits and potential reversal points.

The CD leg is just a 100% fib extension of the AB leg from point C.

Once you start looking for them you will see them all the time in any market that you might trade.

Let’s take a look how you can use this pattern.

Assume one of your strategies generated a trade that you took somewhere in the green highlight. You can use the 100% extension as your take profit. Do some testing, you will be surprised at how well this works.

Not an ABCD Pattern, but in strong trends or bounces off of significant levels you can target the 123.6% or 161.8% extensions for your exit.

For example, maybe point A was a significant support level that price rallied hard off of several days ago. Having this information you may decide to target the 123.6% or 161.8% extension versus the 100% extension.

3. Sizing Up

Being a scalper, it’s not often that I size up into a trade. Usually I trade around a core position, meaning I put my entire position on all at one spot and will exit some of the position as it moves in my favor and add back at better prices.

If you want to do some backtesting to get some data on sizing up with one of your strategies you can use fibonacci levels. I’d start with the 50% level and in stronger trends 38.2%.

4. 50% Retracements (Halfway Back)

Saved the best for last 🙂 This is actually a complete trading strategy that you can test out once you learn.

This isn’t a strategy I have ever personally traded, but I’ve known some successful fib traders who employ like strategies.

Start by setting up a chart with the following settings:
-144 tick Heikin Ashi chart
-Open your fibonacci retracement tools and set the following fib levels: 0, 50%, and 61.8%, and -23.6%.

Don’t have a charting platform yet? Don’t know how to setup a chart like this? You’re in luck.

In the example below I’m going to use TD Ameritrade’s Thinkorswim platform because you can get a free demo account that has everything you need to do some testing on this strategy.

When you open up the platform in the upper toolbar click on charts and you will have a standard candlestick chart.

1. Chang the chart symbol to /NQ which is the eMini-Nasdaq 100.
2. In the blue toolbar click on the time frame setup>timeframe>aggregation type>tick and you should see the standard setting of 144 ticks. Hit ok.
3. Go back to the blue toolbar and click on Style>Chart Type>Heikin Ashi
4. Go back to the blue toolbar and select drawings>drawing tools>and select the % symbol which is the fib tool.
5. Draw a fib retracement and then right click on one of the fib lines and select edit properties.

Copy the fib settings you see above so that you have the fib levels seen on the chart.

Let’s begin breaking down the 50% retracement strategy.

Entry
-Wait for a reversal in trend and a swing high to break (uptrend) or a swing low to break (downtrend)
-Draw a 50% retracement and place a limit order just in front of the 50% level

Trade Management
-Place your stop so that is behind the 61.8% retracement level (failure point)
-Place your take profit at the -23.6% extension

Another option for managing your take profit is after the -23.6 extension is hit draw a new fib retracement from the new swing high and low and trail your stop behind the 61.8 as seen below.

Continue to draw new fib retracements as new swing highs and lows form until you’re stopped out as seen below.

At this point you have a pattern or a setup to trade, it’s still not a strategy, or at least how we defined it thus far isn’t a strategy.

I doubt trading every halfway back that occurred after a swing break would be profitable over a long series of trades.

In your testing begin to develop some context around the setups.

For example, in the above example maybe your context was that a double top occurred at a some significant level. (Prior Day High/Low, VWAP, HVN, etc.)

Now does that mean it’s profitable at this point? No, but now you a more defined strategy that you can backtest to see if it has potential.

Here’s some additional ideas you test in terms of building context…

1. Test setups off of High Volume Nodes
2. Test setups that occur on bounces off longer timeframe 50% retracements. Example: Look for 50% retracements on a 15 minute chart and then look to enter a halfway back setup on your tick chart off that level.
3. If you trade US Index futures you could test setups with swings that formed at extreme NYSE Tick readings
4. Test setups that bounce off of VWAP

The list goes on and on. When you start developing and backtesting your strategies like this you’re going to find much more success because you can find out what’s actually profitable.

Furthermore, for a strategy to be effective it has to be repeatable and it can only be repeatable if it defined in detail.

Finally, you don’t have to use a heikin ashi tick charts for this strategy. I just thing it’s easier to see the swings and trends.

The size tick chart you’re going to use depends on the instrument and really it just takes some testing.

The eMini S&P 500 has a lot higher volume than the eMini Nasdaq 100 so you’re going to want to use a higher tick reading or you would have a new bars forming way too fast.

If you play around you can find what works best for different instruments.

Conclusion

Fibonacci retracements are great for building context around your trades or to develop complete trading strategies.

I’ve been using Fibs since I began my career 20 years ago. They worked then, and they continue to work today.

Make sure to always spend some serious time backtesting and SIM trading any strategy before taking them live.

If you have any questions make sure to leave a comment below!