Fibonacci Retracement Tool

The Fibonacci Retracement Tool is an easy charting tool to learn, but requires practice to master its price projection power. Like most Fibonacci Tools, knowing where to place the anchor points of a Fibonacci Retracement Tool on a stock chart is the key part of using the tool.

A Fibonacci Retracement Tool is best used at the beginning of a potential pullback. Once placed, the tool will identify key areas where the stock’s share price should find support during its pullback.

The identification of support levels can aid in the decision to hold or to sell shares. It can also help to estimate the depth of the upcoming correction or pullback that is anticipated.

In more advanced applications, the Fibonacci Retracement Tool can also be used to calculate upside price targets (see the tips & warnings section).

Components

The Fibonacci Retracement Tool is similar to the Fan Tool in that it is easy to place on a stock chart. The various components for a Fibonacci Retracement Tool include:

• 2 Anchor Points – Anchor Points are used to place the Fibonacci Retracement Tool on a stock chart.
• Retracement Lines – The Retracement Lines are automatically calculated and drawn after the 2 Anchor Points have been placed on the stock chart. The Retracement Lines calculated and automatically drawn are:
  • 23.6% *
  • 38.2%
  • 50.0%
  • 61.8% (phi)
  • 78.6% *
  • 100%
  • 161.8% (Golden Ratio) *
  • 261.8% * 

* Not shown on the below illustration – see the tips & warnings section

Just like the other Fibonacci Charting Tools I cover, the Fibonacci Retracement Tool can be used on candlestick charts covering different lengths of time such as 5 minute charts, hourly charts, daily charts, weekly and even monthly charts. I find the Fibonacci Retracement Tool to be equally effective when used on any of these time frames.

Chart Placement

Pull up a candlestick chart[s2If !current_user_can(access_s2member_level1)]…….If you want to continue learning about things like:

• the components of a Fibonacci Retracement Tool
• how to use the tool to monitor pullbacks and calculate support areas
• advanced techniques, like how to use a Fibonacci Retracement to estimate upside price targets
• tips and warnings when using this tool

you must first sign in. If you are not a Trendy Stock Charts member, consider one of the subscription plans.[/s2If][s2If current_user_can(access_s2member_level1)]of a stock that you are interested in purchasing and that has also begun pulling back in price after a recent uptrend. Next, select the Fibonacci Retracement Tool from your trading platform’s list of charting tools.

1. Start by going to the bottom of the downtrend and placing Anchor Point #1 at the very beginning of a downtrend on the stock chart you are analyzing. This is performed by left clicking the mouse at the price level and area you want the Anchor Point placed.
2. Place Anchor Point #2 at the end of the downtrend from Anchor Point #1 (left mouse click).

After both Anchor Points have been placed on the stock chart, the Retracement Lines are then automatically calculated and projected on the chart. The 38.2%, 50.0% and the 61.8% Retracement Lines are the most commonly used areas to look for other trend reversal indicators, such as a bullish reversal candlestick pattern or a bounce off the 20 or 50 Day Moving Average.

Fibonacci & Elliott Wave Relationships

Knowing where a stock’s share price may be at in its overall Elliott Wave structure can lead to being able to develop certain expectations, or pullback ranges for the stock’s share price. This next cheat sheet discusses the Fibonacci retracement percentages that are typically seen at different parts in an Elliott wave structure.

[su_frame align=”center”] [/su_frame]

All Retracement Lines provide support but at different areas during an uptrend. The 61.8% and the 100% Retracement Lines typically provide support during the early part of an uptrend. The 38.2% and the 50% Retracement Lines typically provide support during the middle to upper-middle phases of an uptrend. Due to the volatile nature of most stock’s share price near the end of an uptrend, Fibonacci Retracement Tools do not work as well as the uptrend is nearing its end.

And if you do not know where a stock is at in its overall Elliott Wave structure, then consider using the above Fibonacci Retracement Cheat Sheet to help with identification of the stocks overall as well as current Elliott Wave Pattern. The above cheat sheet is different from the cheat sheet in the Advanced Elliott wave patterns section. So be certain to print out the above cheat sheet too.

Tips & Warnings

[su_spoiler title=”Remove Some Retracement Lines” style=”fancy”]

Unless you are a day trader, remove the 23.6%, 78.6%, 161.8% and the 261.8% Retracement Lines from the Fibonacci Retracement Tool’s template in your trading platform. This is usually accomplished in the settings area for the Charting Tools.

In my opinion, any retracement greater than 100% can be better estimated and analyzed using a Fibonacci Extension Tool, therefore all percentages higher than 100% on a Fibonacci Retracement Tool should be removed from the Tool’s template.

Eliminating some Retracement Lines helps me to focus on the on the Retracement Lines that statistically have a higher degree of accuracy when analyzing pullbacks:

• 38.2% (inverse of phi)
• 50.0%
• 68.2% (phi)
• Full Retracement (I consider a Full Retracement to be from 80%-100%)[/su_spoiler]

[su_spoiler title=”Two Is Better Than One” style=”fancy”]

At a minimum, place at least 2 different Fibonacci Retracement Tools on a stock chart. The first Fibonacci Retracement Tool should be placed on the stock’s recent uptrend that has started to correct. The second Fibonacci Retracement Tool should be placed on the longest uptrend on the stock chart – this can provide you with a quick downside risk analysis on a longer-term basis in case the support areas from the shorter-term Fibonacci Retracement Tool fail to provide adequate support for the share price.[/su_spoiler] [su_spoiler title=”Watch The 50% Retracement Line” style=”fancy”]

After a stock’s pullback has completed and starts moving sideways for a bit, it probably leaves you wondering which way its share price is going to move. Well, one indicator that I have picked up from watching several charts is that when a stock’s share price consolidates mostly under the 50% Retracement Line, any resulting upwards move for the share price will not be that strong.

Conversely, when the consolidation takes place mostly above the 50% Retracement Line, I typically then anticipate a full retracement of the downtrend and attempts at new highs.[/su_spoiler] [su_spoiler title=”Calculate Price Objectives After A Downtrend” style=”fancy”]

Just like all uptrends that are corrected by some form of downtrend, all downtrends also go through a “correction” period were it is corrected with an uptrend. Fibonacci Retracement Tools can help to calculate these upside price objectives.

This is a 2 year daily candlestick chart for FireEye (FEYE). I overlaid a Fibonacci Retracement Tool on its largest downtrend on the chart. At the very minimum, the downtrend will correct to the 38.2% Retracement Line as long as the stock’s “story” remains in place.

Getting in below the $30 level after seeing other bottoming signals allowed me to then ride FEYE’s share price up to the 38.2% Retracement Line, where I sold some shares. I am currently watching for FEYE’s second attempt at breaking through the 38.2% Retracement Line. Some increased buying volume is going to be needed for the breakthrough.[/su_spoiler] [su_spoiler title=”The Confidence Trade Set-Up” style=”fancy”]

I define a Confidence Trade Set-Up when there are 3 or more technical analysis methods that all point towards the same price objective. Any combination of 3 technical analysis methods will work, such as Candlestick Analysis, Fibonacci Analysis and P&F Charting. But here are a couple of specific combinations of Charting Tools that give me the greatest confidence to go long and execute a share purchase when they are all confirming a trend reversal in the same area:

• A Fibonacci Retracement Tool, a Fibonacci Fan Tool and a Bullish Reversal Candlestick Pattern
• A Fibonacci Retracement Tool, a Main Supporting Long-Term Trendline and a Bullish Reversal Candlestick Pattern
• A Fibonacci Retracement Tool, a 20 Day or 50 Day Moving Average and a Bullish Reversal Candlestick Pattern
• A Fibonacci Fan Tool, a 20 Day or 50 Day Moving Average and a Bullish Reversal Candlestick Pattern

Adding a 4th or 5th technical analysis method of confirmation starts to really get me excited….and when the potential trade has a Risk to Reward Ratio that is 1:3 or better along with a 5 method Confidence Trade Set-Up, holy cow! Those sort of set-ups usually encourage me to risk larger percentages of my total portfolio on the trade![/su_spoiler] [su_spoiler title=”Practice, Yes Practice” style=”fancy”]

Did I mention that you should practice? Yes, practice. I will repeat that one of the best methods that I used to when learning how to use the various Trading Tools was to practice with old chart history. Practicing with old chart history works with every type of Charting Tool and will help you to become a better chart technician.

Placing the Fibonacci Retracement Tool on dozens and dozens of older charts and then seeing how a stock’s share price interacted with the Tool’s Retracement Lines provided me with tremendous insight, it will do the same for you too if you practice.[/su_spoiler]

Real Chart Examples

So now that you have an understanding of the components of the Fibonacci Retracement Tool, let’s use the Tool on an actual chart. I selected a very popular stock for this next illustration, Apple (AAPL).

Here are the steps I followed when placing the 2 anchor points on AAPL’s chart.

1. The beginning of AAPL’s uptrend is $89.47, so that is where I placed Anchor Point #1.
2. Anchor Point #2 was then placed at the end of that uptrend, which had an intra-day high of $118.69.

This is a 6 month daily candlestick chart for AAPL.

Notice how most of the price action for AAPL is taking place above the 50% Retracement Line? I tend to classify this price action as bullish and constructive for a farther advance upwards. However, from an Elliott Wave perspective, there is still a chance for its share price to reach the 61.8% Retracement Line.I expect that would come from a disappointing earnings, which is right around the corner, less than a month away on its charts.

Because of the lower share price possibility, it can provide you with more confidence in the trade if other bullish reversal indicators are identified.

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