Almost every trader in the course of his career will come across the Fibonacci Levels tool also known as Fibonacci retracements. In an earlier article, we described how Fibonacci Levels work on the Olymp Trade platform. Today we will discuss mistakes and misunderstandings that may arise when using this tool. Any technical analysis tool can be used in the wrong way. Signals to enter positions based on incorrect analysis can result in serious losses.
The main task of Fibonacci Levels is to determine potential support and resistance levels based on measuring upward or downward waves on the price chart.
Incorrect fitting Fibonacci Levels of the beginning and end of the wave
An increasing wave is defined as one that starts from the bottom to the top of a price range. A downward wave is the opposite. Both tops and bottoms are visible to the naked eye and easy to identify. It is equally easy to make a mistake when matching Fibonacci Levels to prices. It is all about consistency. The peaks and troughs are formed from candles. A peak can be defined as the highest body of a candle or the highest shadow of a candle. The opposite is true for the definition of a bottom.
Take a look at the below image of the EURUSD currency pair. Both the top and bottom are included here as candle wicks. See how the price exactly turns back at the 0.382 level.
Now see how a small change can knock you out of an investment opportunity. Below, the bottom has been marked as the bottom of the candle body. According to this measurement, we do not have an investment opportunity because the price does not reach the level of 0.382.
Fibonacci Levels are not a specific strategy but only a possible element of a strategy
The best trading results are obtained by traders who multidimensionally evaluate possible market scenarios. Usually, one tool is not enough to generate effective entry signals. This is no different with Fibonacci Levels. It is therefore worth using additional tools to get confirmation that the price at a certain level really has the potential to turn back. Oscillators can be helpful here.
Take a look at the chart below. The price has reached the 0.50 level and at the same time, the Stochastic has turned back from the overbought zone. As a bonus, we also have a beautiful bearish divergence here.
Using Fibonacci Levels on low time-frames
Theoretically, you can use Fibonacci Levels on any chart. However, the effectiveness of this tool decreases as the time frame of the chart decreases. On a one-minute chart, we often observe that the Fibonacci Levels are very close to each other, so using them will not be accurate. Take a look at the EURUSD chart below.
The most important levels are 0.382, 0.5 and 0.618, and these are where the price most often reverses. As you can see, the levels on the one-minute chart are very close to each other (0.5-0.6 pips). Minor market noise generates larger movements, not to mention spikes and whipsaws, which can easily cross such levels many times. This is when the tool becomes practically useless. So which timeframes should you start using with Fibonacci Levels? You can start with 5-minute charts and above. And the higher the time frame, the better, because the levels are more likely to become support or resistance for the price.
Fibonacci Levels are a valuable tool for determining potential price supports and resistances. Their use should be based on a consistent and precise adjustment of the tool to the measured wave.
The levels are not an entry signal. The signal should come from additional confirmation. This can be achieved by using one of the popular oscillators such as RSI, Stochastic, MACD or CCI.
Using Fibonacci Levels on low timeframes is generally not very effective.
Log in now to the Olymp Trade platform and see how you can draw Fibonacci Levels correctly. Practice, practice, practice!
We wish you a successful trading session
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