Fibonacci Retracement – A Beginner’s Guide, Explained Simply

Potential regions of support and resistance can be spotted with great precision using Fibonacci retracement. Even experienced traders cannot completely manage using this indicator, which is among the most frequently used ones in technical analysis. Traders can understand how to employ the Fibonacci retracement in this article to improve their trading odds of success.

Fibonacci Retracement

What is Fibonacci Retracements?

It is a technique for technical analysis that traders utilize to locate potential levels of support and resistance. The premise behind this tool is that prices potently repeat a predictable section of a move. And following that, they will be carrying on moving in the initial direction. The Fibonacci retracement is the name for this predicted behaviour. It entails employing a tool for drawing that shows price movement levels build on Fibonacci theory.

The Fibonacci sequence was invented by Leonardo Pisano Bonacci. He was an Italian-based mathematician. He discovered a ratio in a pattern-following series of numbers. For each number that follows is the total of the two numbers before it, and the sequence begins on the second number. For instance, 2+1 equals 3, followed by 5, 8, 13, 21, etc. This results in the following sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597 … up to infinity.

Mostly Used Levels

The ratios are the essential component of the Fibonacci theory for traders. Fibonacci sequence ratios are used to compute Fibonacci retracement levels. The ratios 23.6%, 38.2%, 50%, 61.8%, and 100% are the most often utilized. For example, by dividing each one by the one after, it always yields a ratio of 0.618. The result is 1.618, sometimes called the golden ratio, when you flip it over and divide by the number before it.

Traders spot their orders’ entry and exit points using the Fibonacci retracement levels. For instance, a trader may execute a buy limit order close to the 38.2 percent or 50 percent Fibonacci retracement level if he or she thinks that the price of an item is likely to have a slight correction following an upswing. The trader may place a take profit order close to the 61.8 percentage Fibonacci retracement level to generate money if the price does, in fact, decline significantly before rising again.

Functions of this Technical Indicator

Fibonacci retracements are additionally employed in Elliott wave theory to give specific chart patterns more significance. There is no formula in play here, in contrast to other technical indicators. The program produces retracement levels based on the Fibonacci ratios utilizing the whole trendline you have created.

Fibonacci retracement functions by letting you connect the start and the finish of a large market move with a trend line. Following that, the sketching tool displays lines at percentage levels determined using Fibonacci ratios. These lines represent probable future locations of support or resistance. Also, it shows whenever the retracement of the initial move might come to a conclusion.

How to use Fibonacci Retracement?

Traders map where prospective support or resistance levels may appear based on a recent substantial movement. Furthermore, they plan their approach accordingly when using Fibonacci retracement levels. Depending on the preferred strategy, that will mean different things.

For instance, swing traders may attempt to enter a market right after an initial reversal and utilize Fibonacci retracements to determine potential exit levels. This is helpful for risk management since it enables them to determine their trade’s risk-reward ratio in advance. Conversely, breakout traders may utilize Fibonacci extensions to determine when a trend may finally peter out, again to identify a potential exit or determine risk vs profit.

Fibonacci retracements can also control the time to initiate trades to profit from the new run that develops at the end of the current trend. Fibonacci retracements are well-liked because they are forward-looking, unlike many other techniques for displaying support and resistance that rely on past data. Traders may utilize the tool to draw potential points of resistance or support levels as early as a movement is finished without waiting for additional data.

How to depict a Fibonacci retracement?

You can use the steps below to represent Fibonacci retracement on a chart:

  • Launch your trading platform, then select a market.
  • Choose the drawing tool for the Fibonacci retracement.
  • Construct a trend line between the start and end of your market’s latest significant movement (highest and lowest).
  • The tool’s settings should allow you to change things like which levels are displayed.

Of course, whether you’re drawing retracements on a rising or falling trend will determine how the levels relate to your chart. Always show the zero point at the beginning of the retracement on your chart.   

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David Dweck