Identifying support & resistance levels using Fibonacci
Traders can also make use of Fibonacci retracement levels to determine support and resistance prices and enter trades accordingly.
In the above price chart of Nifty 50 we notice a strong rally from ₹14500 to ₹18500 levels.
Reaching a swing high at ₹18500, prices start correcting a little and the stock goes into consolidation zone.
Consider a trader who has strong belief that the bullish trend will continue and wants to enter this share. This is where Fibonacci retracement levels can be used to determine support and resistance prices.
Fibonacci retracement levels at 23.6%, 38.2%, 50%, 61.8%, 78.6% help traders to determine support and resistance for such securities in the trend. It is generally believed that Fibonacci retracement levels will act as support prices when prices cool down after a bull run and thus will provide swing traders to enter the share at a pullback to enjoy the further rally.
We ultimately see that after retracement to 38.2% levels (₹16750) after which there was a runaway gap and the stock once again resumed its bullish trend.
Traders must trade cautiously with the knowledge that though these levels are understood as support prices, there is no guarantee that the prices will not fall below these levels. It may so happen that the stock may go towards a downtrend and price may fall further. Hence swing traders must maintain stop losses to avoid huge drawdown of capital.
In the above graph we see that the share is in a downtrend. Consider that a trader that believes that the prices will fall more, then he can enter into this share at a pullback to retracement levels.
In the above, price falls from swing high of ₹136.90 to swing low of ₹115.89 and then starts consolidating.
Traders can enter at Fibonacci levels with the belief that these levels will act as resistance prices and hope to benefit from the continuing downward trend.
Traders could have entered at 38.2% retracement at price of ₹123.4.
Traders could have entered at 50% retracement at price of ₹126.39.
Traders could have entered at 61.8% retracement at price of ₹128.87.
We ultimately see that the Fibonacci retracement holds good as the price retraces to 50% of fall and then again falls below the swing low of ₹115.89 thereby benefiting the swing trader.
However, these levels are no guarantee that prices won't rise above these levels, so traders must enter with strict stop losses.