The Fibonacci tool is one of the best tools used in technical analysis, can also can be one of the most confusing. There’s a golden ratio that can be found by dividing two numbers to get a third, and then dividing the last with the previous number to get the levels of the Fibonacci retracement tool. The main thing Fibonacci is trying to tell us is that everything moves in a geometrical pattern. For example:

1+1 = 2. 1+2 = 3. 2+3 = 5. 3+5 = 8. 5+8 = 13, etc.

Essentially if you divide 8/13 (numbers closest to each other), it’ll equal close to or exactly 61.8
Essentially if you divide 5/13 (numbers alternate to each other), it’ll equal close to or exactly 38.2

Must you know the calculations in order to use this tool? Nope. It’s already there for you to use; you just need to understand how to apply it to the charts and tie it together with your strategy.

This tool is a great addition to identifying retracements vs reversals within a trend. Beyond that, it can assist you in determining your entry, stop-loss, and take profit! The levels of the Fibonacci Retracement tool are -27 extension, 0, 38.2, 50, 61.8 78.6, and 100. How does knowing this help? Glad you asked!

The -27 extension level can determine where price will go after retracing, so what does that give you? You take profit when using Fibonacci!

The 38.2, 50, 61.8 78.6 are your retracement levels where you will be looking for price to show signs of reversal for the end of the retracement. These levels will potentially give you your entry!

Now, if price continues past the 78.6 level into the 100, it is no longer considered a retracement but a reversal.

Before using this tool, you want to identify the swing high and swing low. Between these two are levels price can retrace to before continuing in the direction of the trend. The Fibonacci tool will then identify these levels by using horizontal lines. These levels will be a percentage between 0 and 100. The way it works is: the trader will be able to decipher which level price may reverse off of by using price action. The lower the level, the faster and stronger price will burst. You cannot use this tool as the sole source of confirmation, as it is simply another confluence. Below, I will give an example of how the Fibonacci tool is used in a trend.

How to place the Fibonacci tool?

In a DOWNTREND, you want to drag the tool from top to bottom. This will place the 100 level at the swing high, and 0 at the swing low. You will need to see a pullback to identify the swing low.