Introduction to Fibonacci Retracement
Fibonacci retracement is a popular tool among technical traders and is based on certain key numbers identified by mathematician Leonardo Fibonacci in the 13th century. This tool is considered to be a powerful method for identifying strategic places for transactions to be placed, target prices or stop losses.
Understanding Fibonacci Numbers and Ratios
The Fibonacci sequence is a series of numbers where a number is found by adding up the two numbers before it. Starting with 0 and 1, the sequence goes 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and so forth.
When it comes to trading, the key Fibonacci ratios are derived from this numerical sequence. Specifically, the Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. These percentages are mathematical proportions prevalent in many parts of the natural world, and also in the financial markets.
Applications of Fibonacci Retracement in Trading
Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur. They are calculated by first finding the high and low of the chart. Then five lines are drawn: the first at 100% (the high on the chart), the second at 61.8%, the third at 50%, the fourth at 38.2%, and the last one at 0% (the low on the chart).
Identifying Potential Reversal Levels
One of the primary ways to use Fibonacci retracements is to identify potential reversal levels on the price chart. Traders watch for the price to move to a Fibonacci level and then bounce back. This can be used as an opportunity to enter a trade with a view to the price continuing in the original direction.
Setting Stop Loss Levels
Fibonacci retracements can also be used to set stop loss levels. Traders can set their stop loss at or near a Fibonacci level. The idea is that if the price has hit a Fibonacci level and moved in the expected direction, it is unlikely to return to that level if the trend continues.
Targeting Price Levels
Finally, traders can use Fibonacci retracements to set target price levels. If the price has bounced off a Fibonacci level, traders might set their target price at the next Fibonacci level up or down, depending on the direction of the trend.
Conclusion
Fibonacci retracement is a powerful tool in a trader’s arsenal. It is based on mathematical relationships that are found throughout nature and, as many traders believe, in the financial markets as well. By understanding and applying Fibonacci retracements, traders can potentially identify strategic entry and exit points more effectively. However, like any trading strategy, it’s important to remember that there are no guarantees of success, and every strategy should be used in conjunction with other tools and indicators to increase its effectiveness.
