How to Use Fibonacci Retracement to Spot Market Tops and Bottoms

You’re probably familiar with Fibonacci retracement. Whether you use it as a compliment to another strategy or to confirm key levels, chances are you’ve worked with it in some manner.
However, I can all but guarantee that you haven’t used it in the way I’m about to show you.
The very notion that the Fibonacci retracement tool can help us identify support or resistance lends itself to another huge advantage that’s as powerful as it is obscure.

What is it, you ask?

It’s a way of identifying major market tops and bottoms. If that sounds too good to be true, I can assure you that it isn’t. And while no method is foolproof, this one has allowed me to make some of the biggest profits of my life over the last couple of years.
By the time you finish this lesson, you’ll understand Fibonacci levels inside and out and be able to use what we know about how they work to confirm potential market tops and bottoms.
As always, be sure to leave a comment at the end of this post and let me know what you think.
Let’s begin.

What is Fibonacci?

The more appropriate question is “who” is Fibonacci?
Leonardo Bonacci – better known as Fibonacci – was an Italian mathematician born around 1170 (contrary to popular belief the exact date is unknown).
He was considered to be the most talented mathematician of the Middle Ages, and for a good reason.
Not only did he develop the Fibonacci sequence, which all Forex traders are familiar with, he also popularized the Hindu – Arabic numeral system in the Western World.
His research on the Fibonacci sequence of numbers is considered to be his crowning achievement. It’s also the most widespread in its use, as you’ll discover shortly.
Like the uncertainty about when exactly Leonardo Fibonacci was born, the same ambiguity surrounds his death, which is estimated to be between 1240 and 1250.

How Does Fibonacci Work?

I would argue that understanding how the Fibonacci sequence works is the most overlooked aspect of trading. After all, most trading platforms give us a Fibonacci retracement tool that has all of the math built-in, so all we have to do is click and drag.

But taking the time to understand the depth and power behind this type of analysis are what will set you apart as a Forex trader. Any time spent adding meaning to a concept you use on a weekly basis is time well spent in my opinion.

Okay, so to get things started, I have a question for you…
What do a plant and a snail shell have in common with the charts we use to trade the Forex market?
You got it – they all have Fibonacci attributes.

Yes, the profit you just made from selling the EURUSD rally at the 61.8% Fibonacci retracement level can, in many ways, be attributed to the study of plants, flowers, and even snail shells. The same levels you use on your charts were first studied in nature. After all, Mr. Fibonacci was by no means a trader in his day. I should note, however, that not all charts play by the rules. You’ll find that some currency pairs respect these levels more than others.

But all in all, it can be a great asset if properly used.
The premise of Mr. Bonacci’s study was to identify a numerical order, or explanation, to a seemingly random world. In the case of many plants, it’s thought that a Fibonacci sequence exists to maximize space and efficiency.

In the trading world, this same sequence (except for the 50% level which is not in the Fibonacci order) helps to explain human behavior. After all, everything you do as technical traders is contingent on a particular pattern of human tendencies.

So just like the plants and snail shells, there is a “method to the madness,” if you will, that helps to explain why certain patterns exist, both in nature and on the charts we use.

Using What We Know to Spot Turning Points

Okay, at this point you know who Mr. Bonacci (better known as Fibonacci) was, and you should also understand the significance of the sequence of these numbers to some degree. If not, be sure to review the links above before moving on.

To sum up, the retracement tool is most often used to identify support or resistance during a pullback in a trend. However, there is a less obvious way to use this to our advantage. Dare I say that what I’m about to show you is even more beneficial than the conventional way of using Fibonacci levels.

You see, most traders use the tool within a limited scope. They plot the levels on a 1-hour or 4-hour chart which spans a few days or possibly a few weeks. Additionally, these same traders only use the tool once the market has turned over or directly within a trending market.

If you’re using the Fibonacci tool only in this manner, you’re missing out big time!
Here’s why…
Let’s say you plot the tool on the NZDUSD daily chart during an uptrend and find confluence at a few levels you had previously identified. Remember that we don’t use the Fibonacci tool to find key levels, only to verify them.