Fibonacci Retracements are probability points where a currency, or stock will "bounce back" to, after a large move, and then continue in the original direction. Think of Retracements in terms of Newton's Laws of Motion: "For every action there is an equal and opposite reaction."
Fibonacci in Forex - The Self Fulfilling Prophecy
All of the magical math in the world will never make Fibonacci retracements true 100% of the time. Period. Thus, a little common sense goes a long way when using any type of mathematical, or technical indicator to trade from. If the market is showing something different than the indicator, enough people believe in something different that the indicator is wrong. Fibonacci retracements are only good so long as enough people are watching and acting on the same information that the collective whole makes the occurrence a self-fulfilling prophecy. What I'm saying is that even if you've opened a trade based on Fibonacci
With the aforementioned in mind, Fibonacci Retracements work on both short and long-term time frames for all types of traders. For this article, we will only look at short-term trading with 4-hour charts.
First, before we even consider a Fibonacci retracements, you need to be able to spot when a move has occurred that would warrant using Fibonacci Retracements. This can be as simple as looking at a chart, and visually seeing that a large move has transpired - and capitulated. What I mean by this is, if when looking at a chart you're expecting to see empirical proof that a move has stalled, you will never be able to do so. You will see some signs, like MACD or Stochastics bottoming out, or a candlestick pattern like a hammer bottom, but you will never know for sure. One way to have a slight bit of assurance though, is to look for candlestick confirmation, something I recently covered in my article Why Confirmation Counts.
Regardless, only countless hours of pouring over charts will give you 'the feel'. Once you are able to infer a move is over, you can begin to apply Fibonacci retracements for profit targets points if you are trying to trade the rebound, or for new entries, if you are waiting to get back into the currency, for a continued move in the same direction, as the previous 'large move.'