What is Fibonacci Retracement?

What is the Fibonacci Retracement?

Fibonacci Retracement is considered a top technical analysis tool used to identify potential price reversal levels in every market (Stocks, Forex, etc).

A Historic Analysis of Fibonacci Retracement

This tool is actually based on a particular sequence of numbers identified by the Italian mathematician Leonardo Fibonacci during the 13^th century AD. The meaning of these numbers is wider than any trader can think. Actually, Ratio 1.618 is spread throughout the universe while it can be found in our nature too. The ancient Greeks have used this ratio in their architecture widely. The famous Parthenon was build based on 1.618. The architect of Parthenon was named Phidias (5^th century BC) and that is why 1.618 is known also as the Phi Number:

Phi Number (φ) = 1.61803398875….. This is known also as the ‘Golden Ratio’.

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The Fibonacci Sequence of Numbers

The sequence is based on the fact that each number is the sum of the previous two numbers, and that continues infinitely. Here are the first numbers of the sequence:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, etc.

Here are some interesting facts about the Fibonacci sequence:

◘ Every number in the sequence is equal to the sum of the previous two numbers

◘ Every number in the sequence divided by the previous number approximates 1.618

◘ Every number in the sequence divided by the next number approximates .6180

◘ Every number in the sequence divided by another two places higher approximates .3820

◘ Every number in the sequence divided by another three places higher approximates .2360

The Fibonacci Retracement

Based on the above sequence some very important ratios are derived.

1) The 23.6% Ratio

2) The 38.2% Ratio

3) The 61.8% Ratio {It is called the ‘Golden Ratio"}

Additionally, some technicians are incorporating two more ratios

4) The 50% Ratio

5) The 78.6% Ratio

Chart: The Fibonacci Retracement in Action

Important Note

The Fibonacci retracement levels should be seen as alert zones for potential trend reversals and not as precise support or resistance price levels. It isn’t safe to place a stop-loss exactly above or below a Fibonacci level before the price has reached and tested that level. Only after the price has tested a Fibonacci level, you should execute the trade and place a stop-loss above or below the recent local low or high. The market is uncertain and there is no point in trying to buy at the bottom or to sell at the highest point of a price movement. Wait until the market proves itself, and only then execute the trade.

Price Alerts using Fibonacci Retracement

The Fibonacci Retracement levels generate trading alerts regarding a resistance area or a support area and a potential trend reversal. Once a pullback starts (point B in the chart) the Fibonacci Retracement levels can be monitored instantly {Levels 23.6%, 38.2%, and 61.8%}. More about the Fibonacci Retracement at TradingFibonacci.com