Fibonacci setbacks

In an upward trend, Fibonacci setbacks are often used to determine a level of support towards where the price will return, to rebound and return to trend.

Let's look at some examples of a bullish market.

The following is a one-hour USD / JPY chart. Here, we find the Fibonacci retracement levels by clicking on the low oscillation point at 110.78 and bringing the cursor to the high oscillation point at 112027. You can observe the levels determined by the software. The retraction levels were 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618).

Now the expectation is that if the USD / JPY retracts to that level, you will find support at one of the fibonacci levels because the traders will place orders at those levels in case the market turns around.

[caption id="attachment_552" align="aligncenter" width="505"] Fibonacci setbacks[/caption]

Now let's look at what really happened after we reached the highest oscillation point. The market was returned to the level of 0.236 and continued to tear the following day to 0.382 but it never really closed below this level. Later that day, the market made an upward move. Clearly, buying at 0.382 would have been a good short-term trade.

 

[caption id="attachment_553" align="aligncenter" width="500"] Fibonacci setbacks[/caption]

Now let's look at how to use Fibonacci reversals in a downward trend case.

This is a one-hour EUR / USD chart. As you can see, the high oscillation point is at 1.3278 on 02/28/05 and the low oscillation point is at 1.3169 a couple of hours later. Reverse levels are at 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236).

The expectation for a downtrend is that if the market retracts at this point, you will find resistance at one of the Fibonacci levels, because traders will be placing sales orders at those levels in case the market tries to recover.

 

[caption id="attachment_554" align="aligncenter" width="500"] Fibonacci setbacks[/caption]

Let's see what happened next. The market did try to recover but barely passed the level of 0.500 reaching 1.3227 and closed below this level. After that bar, it is visible as the recovery and the downward trend continued. It would have been a good trade to sell at the 0.382 level.

 

[caption id="attachment_555" align="aligncenter" width="500"] Fibonacci setbacks[/caption]

Here is another example. This is the hourly chart for GPB / USD.

We had a high swing point at 1.7438 on 7/26/05 and a low swing point at 1.7337 later the same day. Therefore, the regression levels are: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). Looking at the chart, the market seems to try to break at 0.500 on many occasions, but it never succeeds. So placing a sell order at 0.500 would be a good trade?

[caption id="attachment_556" align="aligncenter" width="500"] Fibonacci setbacks[/caption]

If you placed an operation at that level, you would have lost a lot of money. Let's look at what happened. The oscillation point fell to be the lowest part in this downtrend, as the market tries to recover above the highest oscillation point.

[caption id="attachment_557" align="aligncenter" width="500"] Fibonacci setbacks[/caption]

Thanks to these examples we can see how the market sometimes finds at the last moment temporary supports (in upward trends) or resistances (in downward trends) in fibonacci retraction levels.

But, there seem to be some problems, like the fact that there is no way to know what the level of support will be.

At 0.236 the weakest level of support or resistance seems to occur, while the other levels provide support and resistance around the same frequency. Despite this, the graphs above, show how the market tends to retract to the level of 0.382, does not mean that the price will reach that level every time and will retract.

Sometimes, it will reach 0.500 and it will be returned, other times, the market will reach 0.618 and will be returned, and at other times the price will ignore Fibonacci levels.
Recall that the market will not always return to its bullish trend after finding a temporary support, and may continue to fall below the last low swing point. The same thing happens with a downward trend. The market may decide to continue above the last high oscillation point.

Placing stop loss is a challenge.

It is probably best to place the stop losses below the last oscillation point below or above the last high oscillation point. But it requires taking a big risk in proportion to the possible gains that can be obtained or lost.

Another big problem is to determine which high or low swing point to use to start creating Fibonacci retracement levels. People interpret the graphs differently and therefore will have their own opinion of what points would be correct.

In conclusion, there is not a single right way to do it, but the bad thing is that sometimes everything turns into a guessing game.

 

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.