By examining how far the pullback has reached on the Fibonacci scale we can determine whether the price will pull back up again or turn into a bearish trend. As long as the price remains above the 61.8% line we can expect the trend to rise back up indicating a pullback. Once the price crossed the 61.8% line we must treat it as a start of a bearish trend which would indicate that it is time to close the position. For example, in the chart above the pullback forms a bottom at around the 50% Fibonacci marker. This indicates that the price will most likely rise and the overall upward trend will continue.
Fibonacci retracements are often used to identify the end of a correction or a counter-trend bounce. Corrections and counter-trend bounces often retrace a portion of the prior move. While short 23.6% retracements do occur, the 38.2-61.8% covers the more possibilities (with 50% in the middle). This zone may seem big, but it is just a reversal alert zone. Other technical signals are needed to confirm a reversal. Reversals can be confirmed with candlesticks, momentum indicators, and volume or chart patterns. In fact, the more confirming factors the more robust the signal.
On the above example the levels are put between the bottom and the top with 100 at the bottom and 0 at the top. After the peak is found you can then use the retracement levels to predict where it will drop back to. As you can see there is a 50% retracement which then bounces of this level to one level higher before it resumes the downtrend back to the 61.8% retracement level.
Based on the depth you can consider that the 23.6 level to be relatively shallow which could be used in combination with the flag pattern. The main issue with small pullbacks are you do not have the same opportunity to profit as the moves are not very large and require a close watch. The larger retracements of 50-61.8% are more favored as the time to profit from it is larger. You can also use this indicator in combination with others reversal chart patterns such as double tops, head and shoulders, bump and run etc.
Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. However, Fibonacci's sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. This indicator is used to identify potential reversal levels based on the Fibonacci sequence. The main levels within the retracements are 1, 23.6, 38.2,50,61.8 and 100% but many round up or down these numbers when apply to a chart. After a large advance or fall in price, traders will use this to indicate what levels and the price it may retrace to.
The Fibonacci sequence is a series of numbers where the next number is found by adding the two previous numbers together. It can be found in nature when looking at pine cones, sunflowers or even in the way we judge each other facial structure. The retracement levels come from dividing the two numbers next to each other in the sequence such as 13/21 = 0.6180 which is where we have got the 61.8 level. The mathematics behind this processed is complicated but as a trader you just need to know which retracement levels you are looking for and not the reason for it.