Drawing Fibonacci Retracement Areas on Upward and Downward Trend
The stock price on a stock chart doesn't move up/down in a straight line. Instead it moves up or down in a zigzag manner. Fibonacci Retracement is the trading tool used to estimate where the zigzag will stop. The pull back levels are 38.2%, 50% and 61.8%. These form the points at which the stock trading market is likely to make a retracement.
What's retracement? It is a retracement of the stock price before the stock market resumes original trend/original direction of movement.
Explanation of Zigzag Movement: The Examples below shows stock trading price heading upwards in a zigzag manner.
The diagram below shows movement in an upwards market.
1-2: Stock Indices Price moves up
2-3: Pullback
3-4: Moves up
4-5: Pull back
5-6: Moves up
Since we can spot where a retracement starts on a chart, how do we know where it will get to?
The answer is we use Fibonacci retracement indicator.
This is a type of line study used in indices trading to predict & calculate these levels. This stock indicator is placed directly on the stock chart within the platform provided by your broker, This stock indicator will then automatically/mechanically calculate these levels on the chart.
What are The Retracement Levels
- 23.6 %
- 38.2%
- 50.0 %
- 61.8%
38.2% and 50.0% Levels are the most used and most of the time this is where the pull back will get to. With 38.2% being the most popular/liked & most widely used.
61.8% is also oftenly used to set stops for trades opened using this strategy.
This tool will be drawn in direction of the market price trend as described in the exemplification laid-out below.
How to Draw on an Upward Bullish Market
In the diagram below the stock trading price is moving up between 1 and 2 then after 2 it retraces downward to 50.00% pull-back area then it continues heading up in the original and initial upwards trend. Notice that this trading indicator is drawn and plotted from point 1 to point 2 in the direction of the trend (Upward).
Because we know that this is just a retracement based on strategy of using this technical indicator, we put a buy order just between the levels 38.2% & 50.0% and our stoploss just below 61.80% pull-back mark. If you had put buy at this point in the trade illustrations presented below you would have made a lot of pips.
Explanation for the Above Example
Once the trade transaction hit the 50.0 % level, this zone provided a lot of support for the price, & afterwards the stock trading market then resumed the original up trend & continued to move upwards.
23.6% provides minimum support & isn't an ideal place which to place an order.
38.2 % provides some support but stock trading price in this example continued to retrace up to the 50 % zone.
50.00% provides a lot of support & in this example, this was the ideal point to set a buy order.
For this example, the pull back reached the 50.00 % retracement area, but most of the time the stock trading market will retrace up to 38.2 % and hence most of the times traders set their buy limit orders at the 38.2 % level, while at the same time placing and setting a stop loss just below 61.8 %.
How to Draw on a Downward Bearish Market
In the diagram below the stock trading market is moving down between 1 and 2, then after 2 it retraces upto 38.20 % retracement then it continues moving down in the original and initial downward trend. Notice that this indicator is drawn from point 1 to point 2 in the direction of the trend (Downwards).
Because we know this is just a retracement we put a sell order at 38.20% level and a stop loss order just above 61.80%.
If you had put sell order at the 38.20% level such as displayed on the trade transaction below you would have made a lot of pips afterwards. In this trade the retracement reached 38.2% point and didn't get to 50.00% mark. From experience it is always good to use 38.20% because most of the times the pull back doesn't always get to 50.0% mark.
Explanation for the Above Example
The above example is the perfect setup where the stock trading price retraces immediately after touching the 38.2 % Level.
This level provided a lot of resistance for the pull back, this was the best place for an investor to place a sell limit order as the stock trading market quickly headed down after hitting this level.
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