Fibonacci Retracements for Options Traders: When to Enter and Exit

Fibonacci retracements are a powerful technical analysis tool for options traders that can be used to identify support and resistance levels in the markets. The term “Fibonacci” refers to a sequence with ratios that many traders believe are a natural reflection of the patterns you see in human behavior and the market movements that are typical of human behavior. Essentially, it’s a great tool for making better-informed trading decisions and it can be added to your trading arsenal, so long as you know how they work!

Many traders ignore Fibonacci retracements, but could they be the key to timing options trades more effectively?

Our guide on Fibonacci retracements will teach you all about what they are, how they work, how to apply them, and strategies for options trading. You’ll even get to see some practical examples of this technical analysis tool in action for a bit more clarity. Learn about the human behaviors that can influence market movements, but in a format that involves numbers and sequencing. We’ll show you everything you need to know, but we’ll try to simplify it!

What Are Fibonacci Retracements?

Fibonacci retracements are a tool that options traders can use to find potential support and resistance levels. It’s done by plotting horizontal lines on a price chart based on ratios created from the Fibonacci Sequence, an attempt to gauge human behavior patterns in trading and how that translates into the market movements that ensue from those behaviors.

What Is the Fibonacci Sequence?

The Fibonacci Sequence is a tool based on a series of numbers where each number is the sum of the two preceding numbers. A good example of this is the sequence 0, 1, 1, 2, 3, 5, 8, 13, 21. The specific ratios that are generated from the sequence are 23.6%, 38.2%, 50%, 61.8%, and 100%. They are commonly used to predict reversals or pauses in a trend and to set targets and stops. These ratios are known as the Fibonacci Retracement Levels and they’re believed to explain the natural human behavioral tendencies that influence other market behaviors.

What Are Fibonacci Retracement Levels?

Let’s take a closer look at the retracement levels discussed in the prior section. What do they signify? We’ll go over each ratio in the retracements to help you understand how these numbers explain market phenomena and can somewhat predict how human behavior is going to drive the markets.

• 23.6%—Seen as a shallow pullback in a strong trend. This ratio signifies that the price might retrace briefly before it continues in its original direction. In the context of a strong market trend, this ratio can act as a minor support or resistance level.
• 38.2%—This ratio is a major zone for traders who are interested in “buying the dip.” While it’s a more moderate retracement, this ratio can act as a stronger support or resistance level compared to the previous one. The price can stabilize at this point before the trend continues any further.
• 50%—This is often seen as the halfway point in a price movement, which makes it a key level for traders to keep an eye on for potential trend continuations or reversals. Many traders use this point as a way to decide the potential entry or exit points for their trades.
• 61.8%—Many traders consider this to be the “golden ratio” because it appears in the Fibonacci sequence between consecutive Fibonacci numbers. It’s generally seen as a stronger support or resistance number than other retracement levels. Here, the price could either pause or reverse.
• 78.6%—This level represents the potential area where a pullback might find support or resistance before the price continues in the original direction. The price might either pause or reverse before the trend continues onward. Many traders use this level to set profit targets, set stop-loss levels, or enter a trade.

Fibonacci levels can act as potential reversal or continuation points in price action. If the price retraces back to one of these levels and then bounces back up, it could be a signal to traders or investors that an uptrend will continue. On the other hand, a breakdown could possibly point to a potential reversal.

Example of Retracements on a Stock Chart

Fibonacci retracements appear as horizontal lines on the stock price chart, which indicate the potential support and resistance zones, either during a market correction or pullback. Identifying the trends is easy because the lines that go upward signal an uptrend, while the lines going down show a downtrend. When the price movement occurs, there can be a place where the lines peak, which is the “swing high,” or they can dip down into a trough, which is the “swing low.”

Why Fibonacci Retracements Matter for Options Trading

Fibonacci retracements are a helpful tool in options trading, which can help investors improve their market timing and the risk management steps they put into place. They are often used as a part of a trend-trading strategy where traders observe a retracement within a trend in an attempt to perform low-risk entries that go in the direction of the initial trend. The most commonly used ratios are 23.6%, 38.2%, 50%, and 61.8%.

• Identifying Entry Points: Traders can use Fibonacci levels to find potential support and resistance levels, and this can inform the entry point of the trade. The first step is to look for a clear trend and connect the extreme points of the trends. The next step is to watch for the price to pull back to the Fibonacci level, which can act as a potential support or resistance level. Traders need to look for confirmation of a reversal at these levels and then place their stop-loss order slightly below the level used for entry.
• Determining Exit Points: Use Fibonacci levels for profit-taking and stop-loss placement. To make this happen, you must determine an exit point. The first step is to identify clear trends on the price chart, followed by plotting Fibonacci retracement levels by connecting two extreme points of the trend. Next, it’s up to the trades to watch for the price to retrace to these levels and look for price action signals at these levels to confirm a potential reversal. It’s only then that the trade can set their exit point.
• Market Psychology: Traders and algorithms react to Fibonacci levels because they’re perceived by many as areas of resistance or support which could be key indications of the continuation of a current trend or a possible price reversal.
• Volatility Considerations: Implied volatility affects the accuracy of Fibonacci-based options trades due to it affecting option pricing and the reliability of retracement levels provided by the Fibonacci method. Higher implied volatility leads to higher option premiums and it can lead to option pricing being distorted which ultimately makes the Fibonacci levels less reliable for traders who are looking for clear entry and exit points.

How to Draw and Use Fibonacci Retracements in Options Trading

Are you ready to begin using Fibonacci retracements to inform your trading decisions? We’ve laid out a step-by-step guide to applying this technical indicator to your online trading sessions and using them for maximum effect. The steps are relatively simple, but it might take a few go-arounds to get it down right. As always, it’s a good call to use demo accounts or paper trading simulators to your advantage to gain some experience with no financial risk.

Step 1—Choose a Significant Price Swing

The first step in drawing and using retracements in options trading is to identify a significant price swing. This could either be choosing a swing low to a swing high in an uptrend or it could be a swing high to a swing low in a downtrend.

Step 2—Apply the Fibonacci Retracement Tool

On your trading platform of choice, use a charting tool to draw the Fibonacci retracement tool for either the uptrend or the downtrend. A few good examples of trading platforms that have these tools are ThinkorSwim and TradingView.

Step 3—Identify Key Levels

The nice thing about the charting tools you’ll find on platforms like TradingView or ThinkorSwim is that they will plot key retracement levels automatically. Depending on the situation, these levels can be used to identify possible support or resistance levels. At these levels, the price could consolidate or reverse.

Step 4—Confirm Signals with Other Indicators

It’s key to pair the Fibonacci retracements with other technical indicators like the Relative Strength Index, moving averages, or Moving Average Convergence Divergence to cross-check everything for confirmation of trends.

Example

A trader identifies a pullback to the 61.8% Fibonacci level on Tesla (TSLA) and considers a call option based on bullish confirmation signals. The 61.8% level is often considered a strong support or resistance area in the Fibonacci sequence, so a trader is wise to set up a trade to accommodate an emerging trend.

Fibonacci-Based Options Trading Strategies

Check out the options trading strategies that work well in conjunction with the Fibonacci retracement method. You’ll experience a much more harmonious outcome with this technical indicator if you’re pairing it with a conducive options strategy. Check out some examples below of the best strategies that go along well with using retracement levels.

Using Fibonacci Levels to Time Call and Put Options

Traders can use retracement levels to better time their call and put option trades. Fibonacci levels can offer key insights into market trend continuations or reversals, so traders can better prepare positions that are rooted in bearish or bullish market plays.

• Calls: Buying call options when the price retraces to a strong Fibonacci support level. Call options allow the trade to profit from rising stock prices, so this is the best course of action when the retracements are pointing toward an uptrend.
• Puts: Buying put options when the price retraces to a key Fibonacci resistance level. Put options allow the trade to profit from falling stock prices, so this is the best course of action when the retracements are pointing toward a downtrend.

Fibonacci Retracement and Vertical Spreads

Vertical spreads are an option strategy where traders buy and sell options with the same expiration date but different strike prices. Using Fibonacci retracement, traders can find potential support and resistance levels for vertical spreads, specifically in the underlying asset price. This will ultimately determine the entry and exit points of these trades.

• Bull Call Spread: Buying this vertical spread can be beneficial if the market is trending upward. The trader will want to enter a bull call spread when the price finds support at a Fibonacci retracement level. It’s a bullish market approach where you’re buying a call option with a lower strike price and selling a call option at a higher strike price.
• Bear Put Spread: On the other hand, if the market is trending downward, traders might want to implement a vertical spread (bear put spread) using the Fibonacci resistance levels to structure it. This move involves buying a put option with a higher strike price and selling a put option with a lower strike price.

Fibonacci with Iron Condors and Credit Spreads

Fibonacci retracement levels can also be paired well with iron condors, credit spreads, and any other trade that comes with multiple legs. The levels are useful for establishing the entry or exit points of these trades and can be instrumental in building an effective trading plan.

• Iron Condors: Look for Fibonacci levels that could act as the upper and lower limits of a potential range, as the iron condor trading technique is best used in range-bound trades. Use Fibonacci levels to choose strike prices (aim for the underlying asset to stay within the range) as well as to establish potential targets for your exit.
• Credit Spreads: This move involves placing short options at resistance/support levels identified by Fibonacci. Traders can use these levels to place entry orders for credit spreads. Plus, they can be used for setting up the stop-loss and take-profit targets for the trades.
• Bear Put Credit Spreads: Enter a bull put credit spread when you’re anticipating the price of the stock to rise or remain stable, or enter a bear call credit spread when you anticipate the price of the stock to fall or remain stable (entry points).
• Bear Put Credit Spreads: Use bear put credit spreads to exit the trade if the stock price falls below the lower strike price of your put option or if the stock price goes above the upper strike price of your call options. Use bear call credit spreads to exit the trade if the stock price rises above the lower strike price of your call options or if the stock price falls below the upper strike price of your put options (exit points).

Combining Fibonacci with Trend Confirmation

Traders can use this powerful strategy to find the proper entry and exit points for a trade. Combining the retracement levels with other technical indicators is the key to getting the best confirmation of trend continuations or reversals. Check out which other technical indicators are best for using with the Fibonacci sequences and numbers.

• Using Moving Averages: Confirming Fibonacci retracements with the 50-day or 200-day moving average act as trend lines for the trader. Anytime you see a retracement level overlapping with a moving average, you’re likely dealing with a strong support or resistance level. Potential reversals can be spotted when the price crosses a Fibonacci level, but the price is also above a moving average.
• RSI Signals: Another technical indicator that can help traders identify possible trend reversals or continuations, RSI can be used in long positions (uptrends) to see if there are oversold conditions or if the stock trend is in the process of bouncing from oversold territory. For short positions (downtrends), RSI signals can be used to find overbought conditions or stocks that are bouncing back from overbought territory.
• MACD Signals: Look for instances where a retracement level aligns with a MACD signal. This is to ensure momentum supports the trade setup. In a bullish environment, you’ll find good buying opportunities, especially when the price retraces to a support level in an uptrend and the MACD shows a bullish crossover. In a bearish environment, you’ll find good selling opportunities when the price retraces to a resistance level in a downtrend and there’s a bearish crossover with MACD.

Common Mistakes When Using Fibonacci Retracements

Check out the most common mistakes that traders make when they’re new to using Fibonacci retracements. Once you’re familiar with these blunders, you can avoid them altogether, which results in much smoother trading sessions—you’ll be using this technical indicator for best results and not running across pitfalls that could have been sidestepped.

• Forcing Fibonacci Levels: Drawing retracements on insignificant price swings can be a big mistake, especially for traders where their forcing levels are on smaller trends. Fibonacci retracements are best used in significant trends, which are far more reliable for using this technical indicator.
• Ignoring Confirmation Signals: Another common mistake is trading solely based on Fibonacci without secondary indicators. This can lead to inaccurate or premature entries or exits. Ignoring confirmation signals can also lead to impulsive decisions based on emotions of short-term market fluctuations.
• Overtrading: Entering too many trades based on minor retracements can lead traders to overextend themselves in their investments. Excessive buying and selling based on minor retracements will have traders incurring extra fees or commissions that make the trades not worth it in the long run.
• Misjudging Market Conditions: Failing to consider news, earnings reports, and broader market trends can result in using Fibonacci retracement levels for nothing. Along with pairing this tool with other indicators for cross-confirmation, it’s equally important for traders to check the broader market context. Keep up to date on key upcoming events to make projections on where the stock prices could be heading.

Practical Examples of Fibonacci in Options Trading

To use Fibonacci retracements for smarter options trades, it’s critical to know how the application of these indicators would play out in a hypothetical scenario. We’ve included a few examples below of how Fibonacci levels can be applied to a call options trade and a bear put spread.

Example 1—Apple (AAPL) Call Option Trade

When the price retraces to a 50% Fibonacci level and bounces back, this is an indication of a potential support level. It can also be interpreted as the confirmation of an uptrend continuation. Remember that the 50% ratio is largely seen as the halfway point in a price movement which makes it a key level for traders to keep an eye on for potential trend continuations or reversals.

In this scenario, you could use the Relative Strength Index for cross-confirmation of the possible trend. If you’re seeing some bullish RSI divergence and increasing volume, this could be a good confirmation of a potential support level, which would justify the use of a call option. The next step for the investor would be to buy a call option at the retracement level for the Apple stock.

Example 2—Amazon (AMZN) Bear Put Spread

Let’s say you’re dealing with Amazon stock and there’s a rally to the 61.8% retracement but fails to break resistance. Keep in mind that this is the “golden ratio” and is generally seen as a stronger support or resistance number than other retracement levels. Here, the price could either pause or reverse.

Use another technical indicator for cross-confirmation of the trends. For instance, you could use Moving Average Convergence Divergence (MACD) to see if there is a bearish crossover with the retracement levels, which would signal weakness. If the trend is confirmed, the trader could enter a bear put spread to capitalize on the reversal.

Best Platforms and Tools for Fibonacci Trading

Check out our favorite trading apps that carry the Fibonacci tools that traders will need to succeed in their online options trading sessions. In addition, we’ve added the best scanners and indicators the market currently has to offer in the event that you want to use a separate platform from your online trading app.

Top Trading Platforms with Fibonacci Tools

ThinkorSwim — There are several Fibonacci tools offered at Thinkorswim, including extensions, fans, spirals, retracements, and time series. Traders can access these tools under the Activity Tool menu.

TradingView — Traders can use the Fibonacci tool to visualize support or resistance levels by plotting retracement levels. TradingView lets traders plot these levels based on the ratios that are generated from the Fibonacci sequences.

NinjaTrader — Those using NinjaTrader can enjoy using retracements, circles, extensions, and several other relevant Fibonacci tools. Go to the pencil icon in the tool chart to access the drawing tools.

Recommended Fibonacci Scanners and Indicators

• Auto Fibonacci Tools—These technical analysis indicators automatically identify and plot retracements on a chart based on the lowest and highest points of a price movement. Traders can use them to identify support and resistance levels, but they’re a lot easier to use because they simplify the process of Fibonacci ratios.
• Fibonacci Retracement Alert Indicators—This tool alerts traders to possible trend continuations or reversals. They can be set up to provide alerts when the price reaches or breaks through these levels. Alerts can be customized to accommodate for various Fibonacci levels or lookback periods.
• Custom Scripts for Automated Fibonacci Analysis—These custom scripts can automatically identify Fibonacci ratios and draw retracement lines on charts to more easily help traders anticipate price reactions.

Final Thoughts—Mastering Fibonacci for Options Success

Being a technical analysis tool for trading, Fibonacci retracements aren’t exactly required to make a trading plan work due to the best practice of only using three or four indicators max. However, the retracement levels that the Fibonacci sequence has to offer go a long way to explaining the human behaviors behind market movements, which can help traders better identify smart trade opportunities.

If you choose to use Fibonacci retracements in your trading plan, remember to combine them with other indicators for more accurate trading decisions. It’s key to also use the regular risk management techniques in your trading plan alongside these retracement levels such as proper position size, stop-loss orders, and diversification. Another good word of advice from us is to practice using Fibonacci on a demo account before trading in a live market.

Ready to apply Fibonacci retracements to your options trades? Start experimenting with different strategies and refine your edge in the market!