Trade Stock Indices

Drawing Fib Retracement Areas on Upwards and Downwards Trend

The stock price on a stock chart doesn't move up/down in a straight line. Instead it moves upwards or downwards in a zigzag manner. Fibonacci Retracement is the 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 is 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.

Retracement on upward trend

1-2: Indices Price moves up

2-3: Pullback

3-4: Moves up

4-5: Pull back

5-6: Moves up

Since we can identify 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 Upwards 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 upward in the original and initial upward trend. Notice that this indicator is drawn and plotted from point 1 to point 2 in the direction of the market 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% and 50.0% and our stoploss just below 61.80% pull-back mark. If you had put buy trade at this point in the trade illustrations presented below you'd have made a lot of pips.

Fibonacci Drawn on Upward Trend

Explanation for the Above Example

Once the trade transaction hit the 50.0 % level, this zone provided a lot of support for 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 Downwards 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 downward in the original and initial downwards trend. Notice that this indicator is drawn from point 1 to point 2 in the direction of the market 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'd have made a lot of pips afterwards. In this trade the retracement got to 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.

Fibonacci Tool Drawn on Downward Trend

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 moved down after hitting this level.

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