Fibonacci retracement levels can be extremely powerful and critical for swing trading. These levels offer excellent entry points for swing traders who are looking to open a trade on a retracement or pullback.
There are two kinds of fibonacci levels, retracement and extension. However, the ones that play a major importance in swing trading are fibonacci retracement levels and as such will be the main focus.
What are fibonacci retracement levels? Fibonacci refers to a number sequence prevalent in nature that shows trends that adhere to certain percentages. It is believed that through the use of fibonacci ratios, one can find levels that price will retrace to and possibly bounce before continuing on with the trend.
The fibonacci retracement levels used by traders are 0.236, 0.382, 0.500, 0.618 and 0.764. Your trading software should be able to automatically plot these levels on your chart. These levels are important because they are used as possible areas of support and resistance.
Much like support and resistance levels, a swing trader is looking to enter at a fibonacci retracement level harnessing the support or resistance price may meet before continuing on with the trend.
How to draw fibonacci retracement levels
To plot the fibonacci retracement levels you will have to draw from one swing low to a swing high. A swing high is a bar that has at least two lower highs on the left and right side. A swing low is a bar with at least two higher lows on both the left and right.
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Once you have identified the swing high and low, in an uptrend, plot a fibonacci retracement from the swing low to swing high. The example below shows price retracing back to the 50% fibonacci level before it finds support and then continues on up higher.
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To plot fibonacci retracements in a down trend, plot first from a swing high to a swing low. The example below shows price retracing back to the 38.2%/50% fibonacci levels before meeting resistance and then continuing on down.
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Of all the levels, the 0.236 is the weakest. The use of fibonacci levels are far from perfect and a swing trader must always use them with caution. However, fibonacci levels can offer excellent points of entry when price is undergoing a retracement or pullback before it continues on with the major trend.
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