So as for Fibonacci retracements, how can you pick out a retracement level and know that the probability of price reacting to that exact level is on your side every time?
Well the concept is pretty simple and also identical to the one that we use for pivot points and previous levels of support and resistance, and the term we use is confluence.
The concept is simply that we choose the Fibonacci retracement level that has a confluence of other levels of support and resistance at it.
So for example, if you decide to plot a Fibonacci onto a move up you will have several retracement levels to choose from, BUT you may only have one or two retracement levels that have other forms of support and resistance at them, so for example, there may be no confluence at the 38.2%, but you could have a pivot point or a previous level of support or resistance lying right on or near to the 50% retracement level. Having a confluence like this instantly puts the odds in your favour!
Let’s take a look at that on a chart:
In the example above, you can see where the arrow is pointing that there was a really nice confluence of a 61.8% Fibonacci retracement level and a monthly S2 pivot point.
The 61.8% level was pretty much the only one that had such a confluence which means that you could have easily selected this level as the one you would look to sell from as price rallied back up whilst ignoring the other levels.
You can also see how price reacted to that level too, it bounced right off it almost immediately and this is the kind of reaction you will come to expect when trading in this manner.
Just so we are clear a confluence is simply a price where you have multiple levels of support and resistance (i.e. Pivot points or Previous S&R, along with Fibonacci) converging at. Fibonacci retracement levels are just one form of support and resistance that you can look for within a confluence.
One very nice set up or confluence that you can look for just using your Fibonacci tool is an overlap of Fibonacci retracement levels on the price chart.
For example let’s say you have a large wave on the 15 minute timeframe, and you draw your Fibonacci onto it, and then there is a smaller wave that occurs after this first large one, if you apply a Fibonacci to this wave also, you may find that two of the retracement levels overlap, i.e. a 38.2% from the first large wave overlaps with a 61.8% retracement from the smaller wave, this could be considered a good confluence, and is a very powerful set up on its own.
Here is a nice example:
I have drawn the first Fibonacci in black and the second Fibonacci in red to make them easily distinguishable.
As you can see from this example, the overlap does need to be as tight as possible in fact the tighter it looks on the chart the better quality that set up is.
In the example above you can see that there is a clear confluence between the two Fibonacci retracement levels on the chart but more importantly you can see what happens as soon as price hit this confluence.
This concept is really simple but extremely powerful to your trading so always make sure that you’re trading from a retracement level that contains a nice strong confluence of other factors as it is these confluences that give you your edge in the market.