Description: The basic nature of prices is to trend. However, they don’t so in a straight line. Like everything else under the sun, they also witness phases of ebb and flow. They trend for some time, take some rest and then trend again. During these resting periods or consolidating phases, prices tend to retrace a certain portion of their previous advance (or decline) before continuing their journey higher (or lower). Fibonacci Retracements help us to identify these potential reversal zones where such turns are highly likely to happen.
Fibonacci Retracements are nothing but ratios derived from the Fibonacci number sequence discovered during the 13th century by the Italian mathematician called Leonardo Pisano Bigollo also known as Leonardo Fibonacci.
The Fibonacci sequence starts at 0 and 1 and each subsequent number is then derived by adding the previous two. The series progresses to infinity as follows:
0 = 0
0+1 = 1
1+1 = 2
1+2 = 3
2+3 = 5
3+5 = 8
5+8 = 13
13+8 = 21 and so on…….
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377……..
Many important ratios are then derived out of this sequence such as:
1.618: This ratio is derived by dividing a number on the Fibonacci series by the previous number on the series. This is also known as the Golden Ratio which is manifested throughout nature. .
For e.g., 21/13 = 1.6153
34/21 = 1.6190
55/34 = 1.6176
89/55 = 1.6181
The ratio nears 1.6180 as larger numbers are chosen for the calculation. The 161.8% retracement level is based on this ratio.
0.6180: This ratio is derived by dividing a number on the Fibonacci series by the next number on the series. This is the inverse of the Golden Ratio.
For example, 13/21 = 0.6190
21/34 = 0.6176
34/55 = 0.6181
55/89 = 0.6179
The ratio nears 0.6180 as larger numbers are chosen for the calculation. The 61.8% retracement level is based on this ratio.
0.3820: This ratio is derived by dividing a number on the Fibonacci series by a number sitting two places higher on the series.
For e.g., 13/34 = 0.382
21/55 = 0.3818
34/89 = 0.3820
The ratio nears 0.3820 as larger numbers are chosen for the calculation. The 38.2% retracement level is based on this ratio.
0.2360: This ratio is derived by dividing a number on the Fibonacci series by a number sitting three places higher on the series.
For e.g., 13/55 = 0.2363
21/89 = 0.2359
34/144 = 0.2361
The ratio nears 0.2360 as larger numbers are chosen for the calculation. The 23.6% retracement level is based on this ratio.
Apart from the above mentioned Fibonacci retracement levels, many chartists also prefer the 50% retracement level as it marks the halfway point of the prior move during a correction which according to the Dow Theory is an important level to watch out.
While it is impossible to predict exactly which Fibonacci retracement level will hold during a correction, one can look for important candlestick reversal patterns at these levels to improve the odds of success.
In the above example of Tata Steel, we can see how prices reversed sharply upwards after a Doji appeared right at the 61.8% retracement level.
To learn more on proven Fibonacci retracement trading strategies, please read Two Effective Fibonacci Retracement Trading Strategies to Boost Up Your Trading Performance!
You can also attend our Qualified Market Trader stock market course to enhance your trading skills further and gain a better grip on the markets.