Trade Stock Indices

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 pattern. Fibonacci Retracement is the tool used to calculate 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 pullback of the stock price before the stock market resumes original trend/original direction of movement.

Example of Zigzag Movement: The Examples below shows stock trading price heading upwards in a zigzag pattern.

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: Pullback

5-6: Moves up

Since we can spot where a pull-back starts on a chart, how do we know where it will reach?

The answer is we use Fibonacci retracement tool.

This is a type of line study used in indices trading to predict and 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 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 reach. With 38.2% being the most popular & 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 trend as described in the example 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 down to 50.00% pull back area then it continues heading up in the original upwards trend. Notice that this indicator is drawn from point 1 to point 2 in direction of the trend (Upward).

Because we know that this is just a pull-back 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 examples explained below you would have made a lot of pips.

Fibonacci Drawn on Upward Trend

Explanation for the Above Example

Once the trade hit the 50.0 percentage% level, this zone provided a lot of support for the price, & afterward 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 % pull back area, but most of the time the stock trading market will retrace up to 38.2 % and hence most of the time traders set their buy limit orders at the 38.2 percentage% level, while at the same time placing a stop 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 downward trend. Notice that this indicator is drawn from point 1 to point 2 in direction of the trend (Downwards).

Because we know this is just a pull-back 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 as displayed on the trade below you would have made a lot of pips afterwards. In this trade the retracement reached 38.2% point and did not get to 50.00% mark. From experience it is always good to use 38.20% because most 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 zone 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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