Fibonacci Retracement

Fibonacci retracement (or Fib retracement) is a tool utilized by technical analysts to pinpoint essential support and resistance levels. These levels are represented as horizontal lines and are employed to forecast potential reversal points during both uptrends and downtrends. Analysts achieve this by applying Fibonacci ratios expressed as percentages.

The Fib retracement tool originates from a sequence of numbers identified by the mathematician Leonardo Fibonacci in the 13th century, known as the Fibonacci sequence. Specific mathematical relationships among the numbers in this sequence yield ratios that are then plotted on a chart. The key ratios include:

• 0%
• 23.6%
• 38.2%
• 61.8%
• 78.6%
• 100%

These levels are regarded as significant points where prices may either rebound or accelerate. They can assist traders in identifying crucial support and resistance levels, which are valuable for planning entry or exit strategies, such as stop-loss placements. Although not technically a Fibonacci ratio, many traders also consider the 50% level significant, as it represents the midpoint of the price range. Additionally, Fibonacci ratios beyond the 0-100% range, such as 161.8%, 261.8%, and 423.6%, may also be utilized.

To use the tool, traders typically select two extreme points within the price range, such as a high and a low. This range serves as the foundation for further analysis. While the tool is primarily used to map levels within the range, it can also provide insights into important price levels outside of it. The range is usually drawn in accordance with the prevailing trend. In an uptrend, the low point is marked as 1 (or 100%), while the high point is 0 (0%). By overlaying Fib retracement lines on an uptrend, traders can identify potential support levels that may be tested if the market begins to retrace.

Conversely, during a downtrend, the low point is 0 (0%), and the high point is 1 (100%). In this scenario, the retracement refers to the movement from the bottom (a bounce). Here, the Fibonacci retracement tool can offer insights into potential resistance levels if the market starts to rise.

While the Fibonacci retracement tool is not designed to determine the overall price trend, it can help predict support and resistance levels within a significant trend reversal. Traders may utilize Fibonacci levels to identify potential entry points, stop-loss levels, and take-profit levels, which can vary widely based on individual setups, strategies, and trading styles. Some strategies focus on profiting from the range between two specific Fibonacci levels. For instance, in an uptrend followed by a retracement, a trader might buy at the 38.2% retracement level and sell at the 23.6% level.

Fibonacci levels are often combined with the Elliott Wave Theory to find correlations between wave structures and potential areas of interest, creating a powerful strategy for predicting the extent of retracements in various waves of a specific market structure.

Fibonacci numbers are prevalent in nature, and many traders believe they hold significance when charting financial markets. However, like all technical indicators, the relationship between price action, chart patterns, and indicators is not grounded in any scientific principle or physical law. The effectiveness of the Fibonacci retracement tool relies on the number of market participants who are attentive to it. The more traders that focus on the same Fibonacci levels, the greater its predictive power.

These levels are established by selecting two extreme points in a chart's pattern and dividing the vertical distance by the key levels commonly used in trading: 23.6%, 38.2%, 50%, 61.8%, 78.6%, and 100%. Markets exhibit rhythmic movements, where an impulse wave defining a major market trend is often followed by a corrective wave before the next impulse wave reaches new heights. This pattern occurs in both bull and bear markets. The most common method for analyzing corrections is to relate the size of a correction to a percentage of a previous impulsive market move.

In the context of 3-wave patterns, Fibonacci Retracement indicates how far a corrective wave B could extend before wave C emerges. The first support level is marked by 38.2%, and if the price surpasses it, it transforms into a resistance line, with a new support level shifting to the Fibonacci level of 61.8%.

Fibonacci retracements are one of four types of Fibonacci studies used to predict support and resistance levels. They are applied immediately after a significant price movement, either upward or downward. An imaginary vertical line is drawn across the chart between two extreme price values, one high and one low. Subsequently, several horizontal lines are drawn perpendicular to the imaginary vertical at significant Fibonacci values. The most common number of lines is five, drawn at 0%, 38.2%, 50%, 61.8%, and 100% of the line's length (starting from either end), although some traders may use even more retracement lines.

After a strong price movement in either direction, markets tend to "retrace" a significant portion of their price change, and the levels at which this retracement reverses or pauses often align with the horizontal lines on the Fibonacci retracement chart.