DEFINITION of Fibonacci retracement

Fibonacci retracement is a method of technical analysis for determining support and resistance levels.

WHAT IT IS IN ESSENCE

They are named after their use of the Fibonacci sequence. The Fibonacci sequence is a set of numbers that start with a one or a zero. Then comes a one, and continues based on the rule that each number (called a Fibonacci number) is equal to the sum of the preceding two numbers.

Fibonacci retracement is starting from the idea that markets will retrace a predictable portion of a move. After which they will continue to move in the original direction.  

Arthur Merrill in Filtered Waves determined there is no reliable standard retracement: not 50%, 23.6%, 38.2%, 61.8%, nor any other.

The appearance of retracement can be visible to ordinary price volatility as described by Burton Malkiel. He was a Princeton economist.  In his book A Random Walk Down Wall Street, he found no reliable predictions in technical analysis methods taken as a whole.

Malkiel argues that asset prices typically exhibit signs of a random walk. And that one cannot consistently outperform market averages.

HOW TO USE

Fibonacci retracement is a key technical analysis tool.  Traders use it to gain insight into when to place and close trades or place stops and limits. Like other Fibonacci analysis tools, Fibonacci retracements rely on the mathematical principle of the golden ratio. You can use it to find areas of support and resistance in major asset moves. Consequently, the point at which a move is halted before it continues past.

To calculate Fibonacci retracement levels, technical traders draw six lines across an asset’s price chart.

One at its highest point (known as 100%), other at its lowest point (0%).  The third is at its midpoint (50%). And then three at 61.8%, 38.2%, and 23.6% respectively.

According to the golden ratio, these should be points at which significant levels of support and resistance are met.

How to use Fibonacci retracement read HERE

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Fibonacci tools help predict points of support or resistance

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Fibonacci numbers are 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, etc. The sequence occurs by adding the previous two numbers (i.e. 1+1=2, 2+3=5). The main ratio used is .618. This is found by dividing one Fibonacci number into the next in sequence Fibonacci number (55/89=0.618). 

The logic by Fibonacci based traders is that Fibonacci numbers occur in nature. And the stock, futures, and currency markets are creations of nature – humans. Therefore, traders can apply the Fibonacci sequence to the financial markets.

There are many Fibonacci tools such as Fibonacci Retracements used by traders.

In finance, Fibonacci retracement is a method of technical analysis for determining support and resistance levels. They are named after their use of the Fibonacci sequence. Fibonacci retracement is based on the idea that markets will retrace a predictable portion of a move. After which they will continue to move in the original direction.

Use Fibonacci Retracements to Enter a Trade

First of all, no indicator should be used in isolation. But by combining it with trend analysis it helps highlight logical areas for entering trades.

Fibonacci Retracements are considered a predictive technical indicator as they attempt to identify a future exchange rate. The theory is that after a rate spike in either direction, the rate will often return or retrace. Part way back to the previous price level. Before resuming in the original direction.

When the price of an asset pulls back, it typically has a mathematical relationship to the price wave that preceded it.

Moves lower off a recent high, or moves higher off a recent low. 

This relationship is based on the “Golden Ratio” and a series of “Fibonacci Numbers” that help define the numerical relationship of one thing to another.

Interpreting Fibonacci Retracements

Given their popularity and widespread usage by technical analysts, it is good to know how to interpret Fibonacci retracements. However, as with any indicator, it is wise to seek confirmation from additional sources. Just to bolster Fibonacci analysis before basing a large trade.

Once an impulse wave has occurred, the price will quite often move to and stall at one of the Fibonacci Retracement levels. If the price falls through one level it will likely proceed to the next level. Sometimes, a price may stall at one level, then proceed to the next, stall and proceed to the next and so on.

During such periods it is important to have some guidelines. To know on which levels are likely to be most important in certain market conditions. This will require a lot of practice reading price action.

When there are strong trends, what to do?

In a very strong trend, you should expect shallow pullbacks, to 23.6, 38.2 and sometimes 50. In regular trends, or during the middle of a trend expect a pullback to the 50 or 61.8 levels. Early in the trend, late in the trend or during weak trends expect retracements/pullbacks to reach the 61.8 or 78.6 levels.

We can’t know in advance which Fibonacci level will reverse the pullback. Since there are multiple levels, which one it stops can be random. This is why we need some other tools to help make trading decisions. If we opt to use retracement levels.

When it comes to using Fibonacci Retracements as a technical indicator, trader discretion is advised.

The Fibonacci tool works best when the forex market is trending.

Fibonacci retracements provide some areas of interest to watch on pullbacks. They can act as a confirmation if you get a trade signal in the area of a Fibonacci level.

The idea is to go long (or buy) on a retracement at a Fibonacci support level when the market is trending up. And to go short (or sell) on a retracement at a Fibonacci resistance level when the market is trending down.


Fibonacci Retracements are ratios used to identify potential reversal levels. These ratios are found in the Fibonacci sequence.

The most popular Fibonacci Retracements are 61.8% and 38.2%. Note that 38.2% is often rounded to 38% and 61.8 is rounded to 62%. After an advance, chartists apply Fibonacci ratios to define retracement levels and forecast the extent of a correction or pullback. Fibonacci Retracements can also be applied after a decline to forecast the length of a counter-trend bounce.

These retracements can be combined with other indicators and price patterns to create an overall strategy.

Unlike moving averages, Fibonacci retracement levels are static prices. They do not change. This allows for quick and simple identification. And allows traders and investors to react when price levels are tested.

Because these levels are inflection points, traders expect some type of price action, either a break or a rejection. The 0.618 Fibonacci retracement, that stock analysts like to use, approximates to the “golden ratio”.

Basic Fibonacci Retracement Strategy

Fibonacci Retracements are a guide; don’t expect the price to stop exactly at a certain level. For example, the price slightly overshoots at the 61.8 level. It is typical for the price to stall just above or below a Fibonacci level.

Buy when the price pulls back and stalls near one of the Fibonacci retracement levels. And then begins to move back to the upside. Place a stop loss below the price low that was just created. Or below the lower Fibonacci retracement level to give more room. In perfect position, the retracement level you buy at is one that the asset has a tendency to reverse it.

Look for some sort of trade trigger to occur near the Fibonacci level. For example,  the price is up and the price has pulled to near a key Fibonacci level. You should wait for the price to consolidate. And then break out of that consolidation to the upside. This adds a second layer of confirmation. Also, you can watch patterns to trigger a trade.

Without this trigger itis hard to trade Fibo levels on your own.

How to apply 

In a downtrend, sell when the price pulls up and stalls near one of the Fibonacci retracement levels. And then it begins to move back to the downside. Place a stop loss just above the price high that was just created. Or above the higher Fibonacci retracement level to give a bit more room.

Again, add in a trade trigger or some other element of confirmation.

Looking at how strong the trend is can help determine which Fibonacci levels are most likely to stall and hopefully reverse the pullback.

The bottom line

You can apply Fibo to any time frame, including ticks charts, 1-minute charts or weekly charts. Also, you can use retracement levels on any liquid market. And can be applied to individual price waves or multiple price waves. 


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>>> P/E Ratio An Quick Method to Value a Stock

 

When unsure what's the right move, you can always trade Forex

Get the number #1 winning technical analysis ebook for trading Forex to your email.
Containing the full system rules and unique cash-making strategies. You'll be surprised to see what indicators are being used and what is the master tuning for successful trades. Including case-studies and images.
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