Fibonacci retracement is a popular technical analysis tool used by traders and investors to identify potential levels of support and resistance in financial markets. It is based on the Fibonacci sequence, a series of numbers where each number is the sum of the two preceding ones (e.g., 0, 1, 1, 2, 3, 5, 8, 13, 21, and so on).
In Fibonacci retracement, the key Fibonacci ratios used are:
- 23.6%: This is not a true Fibonacci number but is included due to its popularity in technical analysis.
- 38.2%: This is the result of dividing a number in the Fibonacci sequence by the number two places to the right.
- 50%: While not a true Fibonacci ratio, this level is often included in Fibonacci retracement analysis.
- 61.8%: Also known as the “golden ratio,” this is another key Fibonacci level and is found by dividing a number in the sequence by the number one place to the right.
To use Fibonacci retracement, you start by identifying a significant price move on a chart, whether it’s an uptrend or a downtrend. Then, you draw horizontal lines at the above-mentioned Fibonacci retracement levels (23.6%, 38.2%, 50%, and 61.8%) from the high point to the low point in the case of a downtrend or from the low point to the high point in the case of an uptrend.
The idea behind Fibonacci retracement is that these levels may act as potential areas of support (in an uptrend) or resistance (in a downtrend) where the price could reverse or consolidate. Traders often use these levels to identify entry and exit points, set stop-loss orders, and gauge the strength of a trend.
It’s important to note that Fibonacci retracement is not a guaranteed predictor of price movements but rather a tool that can provide potential price levels of interest. Traders typically use it in conjunction with other technical analysis tools and indicators to make informed trading decisions.