Technical Classroom: How to use Fibonacci Retracement Levels in stock trading

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

A Fibonacci retracement is a popular tool among technical traders and is based on some key numbers. The origins of the Fibonacci series can be traced back to the ancient Indian mathematic scripts, with some claims dating back to 200 BC. However – in the 12th century - Leonardo Pisano Bigollo, an Italian mathematician who was known to his friends as Fibonacci, discovered Fibonacci numbers.

It is a popular tool that technical traders use to help identify price levels for transactions, stop losses or target prices. These retracement levels also provide support and resistance levels for a stock. However, it really becomes most effective when confirming signals or conditions identified by additional technical analysis tools.

Fibonacci Retracement is a method of technical analysis for determining support and resistance levels. It is named after the use of the Fibonacci sequence series. It is also 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.

Fibonacci Retracements are ratios used to identify potential reversal levels, and the most popular Fibonacci Retracements are 61.8 percent and 38.2 percent.

Construction of Fibonacci Retracement

Fibonacci Series

The understanding underlying formula used for the construction of Fibonacci Retracement levels helps traders to take a prudent decision, while trading complex scenarios. Fibonacci numbers are a sequence of numbers in which each successive number is the sum of the two previous numbers. The Italian mathematician described a very important correlation between numbers and nature. He introduced this number sequence starting with only two numbers 0 and 1.

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, and so on.

The Fibonacci sequence starts from 0 1 and every number thereafter is built by the sum of the previous two.

Every number in the Fibonacci sequence is 61.8 percent of the next number.

Numbers in the Fibonacci sequence are 38.2 percent of the number after the next in the sequence.

Every number in the Fibonacci sequence is 23.6 percent of the number after the next two numbers in the sequence.

The volume of each part of the Sea Shell matches exactly the Fibonacci numbers sequence. Thus, each part of this shell is 61.8 percent of the next. It works the same way with this aloe flower. If we separate the aloe flower into even particles, following the natural curve of the flower, we will get the same 61.8 percent result. This ratio is not only found in animals and flowers. This ratio is literally everywhere around us. It is in the whirlpool in the sink, in the tornados when looked at through satellite in space or in a water spiral.

The Fibonacci ratio is constantly right in front of us, and we are subliminally used to it. Thus, the human eye considers objects based on the Fibonacci ratio as beautiful and attractive. Also, big corporations like Apple and Toyota have built their logos based on the Fibonacci ratio.

Strong Uptrend

Defining the primary trend with Fibonacci requires one to measure each pullback of security. If one sees a series of new highs with retracements of 50 percent or less, the stock is in a strong uptrend.

Sideways Market

If one sees retracements of 61.8 percent, 78.6 percent or 100 percent, the stock is likely in a basing phase before the next move.

The Fibonacci Retracement is available on most trading platforms, such as Tradingview and MetaTrader. The Fibonacci Retracement Candlesticks are also available on many free online charting sites, such as Investing.com, StockCharts.com, and Yahoo! Finance.

Working of Fibonacci Retracement levels

- Countertrend moves tend to fall into certain parameters, which are often the Fibonacci Retracement levels.

- Fibonacci retracement levels are most frequently used to provide potential areas of interest. If a trader wants to buy, they watch for the price to stall at a Fibonacci level and then bounce off that level before buying.

- At the end of the day, Fibonacci is nothing more than simple retracement levels. These levels are the only representative of where security could have a price reaction, but nothing is etched in stone.

- Fibonacci Retracements are displayed by first drawing a trend line between two extreme points. A series of six horizontal lines are drawn intersecting the trend line at the Fibonacci levels of 0.0 percent, 23.6 percent, 38.2 percent, 50 percent, 61.8 percent, and 100 percent.

- Unlike moving averages, Fibonacci retracement levels are static prices. They do not change. This allows 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 retracement concept is used in many indicators such as Tirone levels, Gartley patterns, Elliot Wave theory and more.

Get a 2 days free trial in Stock Market Tips and MCX Tips