Fibonacci retracement and extension are popular tools used to determine support and resistance levels. Before Leonardo Fibonacci introduced them to Europe, the Fibo numbers and their sequences were developed by Indian mathematician Acarya Virahanka around 600 AD.
Fibo levels determine price pullbacks within a solid trend and trend reversals. Although the indicators consist of lines only, many traders draw them wrong and think they don’t work. In this article, you will learn how to draw Fibonacci levels correctly.
How to draw Fibonacci retracements
The Fibonacci retracement tool is used to determine how deep a retracement within a current trend can be. This means that retracements measure price pullbacks within a trend.
The Fibonacci retracement consists of a line that connects a pick and low of a trend and the levels, including 0%, 23.6%, 38.2%, 50%, 61.8%, 78.6%, and 100%. 0% and 100% stand for the highest and the lowest points of the trend. 23.6%, 38.2%, 61.8%, and 78.6% are considered the golden ratio. They are essential for identifying price pullbacks. 50% is considered a psychological level.
How to draw the lines
- Choose “Fibonacci retracement” on the trading platform you use. It’s a standard technical tool.
- Find the highest and the lowest points of the current trend. If it’s an uptrend, draw the Fibo line from bottom to top. If it’s a downtrend, draw the line from top to bottom.
- If you draw it correctly, the 0% will be located on the top in an uptrend and on the bottom in a downtrend.
How to draw Fibonacci extensions
Extensions are used to forecast the direction the price will move after a retracement. It measures the impulse waves within the current trend. The Fibo retracement tool is represented by two lines connecting a wave’s highs and lows.
How to draw the lines
- Choose “Fibonacci extension” among the trading tools.
- Here, you should look for price swings, not a trend. Every time a price forms a new swing, you can draw a Fibo extension. If it’s an uptrend, pick a low, set a second point on a near high, and connect it to a near low. In a downtrend, pick a high, connect it to a low, and lead the line to a near high.
- If you draw it correctly, the 0% will be located on a low in an uptrend and on a high in a downtrend.
Common mistakes when drawing retracements and extensions
There are common mistakes most traders make when dealing with Fibonacci retracements and extensions.
New Fibo extensions should be placed on the chart every time the price forms a new wave. New Fibo retracements should be placed when the price forms a new trend or a new high/low within the current trend.
Trying to fit
A common mistake when drawing Fibo levels is to fit the Fibo levels with the price movements. Fibonacci levels determine support and resistance levels. Still, it’s normal if the price goes beyond them.
Many traders expect the Fibo levels to show when a trend will turn around. Still, in most cases, the levels identify price reversals but can’t solely predict a change in the whole trend.
Relying on Fibo solely
There is no indicator that would provide perfect signals. Combine the tool with other indicators predicting price reversals, including RSI, MACD, Awesome Oscillator, and Stochastic.
Too many levels
Fibonacci levels work better on longer-term timeframes. As they have to be reset every time a price forms a new trend or a wave, there can be too many levels on low timeframes.
It’s a challenge to place Fibonacci levels on a price chart correctly. Before using this tool for trading, you should practice on different timeframes and multiple assets. A real market isn’t as perfect as it’s in a picture in a tutorial. Use a demo account to understand how to deal with Fibo levels.