Fibonacci Retracement Meaning Levels Calculate Uses

Fibonacci Retracement Meaning

Traders obtain the pattern by drawing horizontal lines for support and resistance levels and a potential trading price range for specific assets. It is a powerful tool for identifying bullish and bearish trends and placing entry orders accordingly to make profits. In simpler words, retracement is the difference between the high (peak) and low (trough) prices of an asset for the forecast period after applying Fibonacci percentages.

Key Takeaways

Fibonacci retracement is a technical trading pattern that helps traders identify support and resistance levels at which the existing trend, whether upward or downward, will rebound or reverse.It uses the Fibonacci sequence of natural numbers (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and 55 to infinity) to calculate these levels. The unique attributes of these numbers give retracement ratios (23.6%, 38.2%, 61.8%, and so on) that help predict retracement in the asset value.The Fibonacci retracement levels enable traders to decide on placing buy and sell orders and identify the two extreme points (peak and trough) for buying or selling assets to make more profits.

How Does Fibonacci Retracement Work?

In financial marketsFinancial MarketsThe term “financial market” refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more, fluctuation in asset prices is normal and occurs as impulses and pullbacks. Based on the direction of price movement, investors and traders can make profits or suffer losses. Therefore, they must rely on technical analysis and use related tools to their advantage. Fibonacci retracement strategy determines two price levels at which reversal of a pullbackPullbackA pullback occurs when the price of a stock or commodity pauses or goes against a prevailing trend in the stock market. It is a temporary dip in a generally upward trending asset price. Unlike ‘reversal,’ which are more permanent price drops, a pullback remains only for a short while.read more may happen. It is then quickly followed by retracement per the trending direction.

Retracement is a popular technical tool for investors to determine the Fibonacci levels, at which an uptrend or downtrend is likely to rebound or reverse. The retracement pattern is created using the Fibonacci numbers, introduced by Italy-based mathematician Leonardo Fibonacci in the 13th century.

Fibonacci Numbers

Fibonacci numbers are nothing but a series of natural numbers, beginning with 0 and 1 and continuing infinitely. Each next number in the series is derived by adding two previous numbers. Hence, the numbers formed are:

0 + 1 = 1

1 + 1 = 2

1 + 2 = 3

2 + 3 =5

3 + 5 = 8

5 + 8 = 13

8 + 13 = 21

13 + 21 = 34

21 + 34 = 55

34 + 55 = 89

55 + 89 = 144, and the sequence extends to infinity.

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It is also found that whenever any number in the series is divided by its immediate predecessor, the ratio obtained is the same, i.e., 1.618. This ratio is termed the Golden Ratio. For example:

55/34 = 1.618

89/55 = 1.618

144/89 = 1.6179 = 1.618

Fibonacci Ratios or Percentages

The pattern in these numbers, when computed further, gives a percentage called Fibonacci percentage. This time each number is divided by its succeeding numbers at first, second, and third positions. These Fibonacci trading percentages are used in the stock markets to predict support and resistance levels for the existing trend.

For example, when any number in the series is divided by its immediate successor, the ratio obtained is 0.618 (e.g., 89/144 = 0.618). Similarly, by dividing any number in the series by a number placed two places higher, the quotient obtained is 0.382 (e.g., 55/144 = 0.382). Likewise, when any number is divided by a number placed three places higher, the ratio is 0.236 (e.g., 34/144= 0.236).

Each ratio is an indicator of how strong would be the reverse momentum. In other words, the higher the percentage is, the longer would be the price reversal trend.

When written in percentage format, these quotients become 61.8%, 38.2%, 23.6%, and so on. These percentages determine the Fibonacci levels and help investors predict the reversal of the upward or downward trend. Traders often use the unofficial Fibonacci ratio of 50%, which is considered a part of Fibonacci retracement levels but comes from the Dow TheoryDow TheoryThe Dow theory is founded on ideas derived from Charles H. Dow’s editorials. It fundamentally states that a significant shift between bear and bull sentiment in a stock market will occur when multiple indices confirm it.read more.

How To Calculate Fibonacci Retracement Levels?

There is no specific formula to determine retracement levels. However, traders can draw them on a stock chartStock ChartStock chart in excel is also known as high low close chart in excel because it used to represent the conditions of data in markets such as stocks, the data is the changes in the prices of the stocks, we can insert it from insert tab and also there are actually four types of stock charts, high low close is the most used one as it has three series of price high end and low, we can use up to six series of prices in stock charts.read more by identifying the trend and considering the potential price range (high or peak and low or trough) for a specific asset at support and resistance levels. In the next step, they need to calculate the difference between the two prices to find a target priceTarget PricePrice Target in the context of stock markets, means the expected valuation of a stock in the coming future and the valuation may be done either by the stock analysts or by the investors themselves. For an investor, price target reflects the price at which he will be willing to buy or sell the stock at a particular period of time or mark an exit from their current position.read more. Lastly, they have to multiply the resultant with a Fibonacci ratio or percentage and subtract it from or add it to the high or low price, depending on the trend.

The most commonly used ratios include 23.6%, 38.2%, and 61.8%. Based on the price trends of an asset in the financial market, traders rely on the following formula to calculate Fibonacci levels:

Uptrend Retracement = High Swing – ((High Swing – Low Swing) × Fibonacci percentage)

Downtrend Retracement = Low Swing + ((High Swing – Low Swing) × Fibonacci percentage)

Let us consider two scenarios – uptrend and downtrend.

For example, assume an asset recording a high swing of $150.44 and a low swing of $140.56 in an uptrend. In that case, the uptrend and buy order would be:

$150.44 – $140.56 = $9.88

Hence, the uptrend retracement for the asset at the Fibonacci ratio 38.2% at the support levelSupport LevelSupport level (SL) refers to a point in the securities trading below which the price of the security does not fall.read more would be:

Uptrend Retracement = $150.44 – (($150.44 – $140.56) x 38.2%)

$150.44 – ($9.88 x 0.382)

$150.44 – $3.77

$146.67

Similarly, if high swing for an asset in a downtrend is $160.76 and low swing is $154.64, the downtrend and sell order would be:

$160.76 – $154.64 = $6.12

Hence, the downtrend retracement for the asset at the Fibonacci ratio 61.8% at the resistance level would be:

Downtrend Retracement = $154.64 + (($160.76 – $154.64) x 61.8%)

$154.64 + ($6.12 x 0.618)

$154.64 + $3.78

$158.42

The retracement for different Fibonacci percentages in both trends can be obtained in the same way.

Uses Of Fibonacci Retracement

Fibonacci retracement strategy is more common in the stock market, whether it is an uptrend or downtrend. The nature of financial markets is such that each tradable asset rebounds or reverses upon reaching a certain retracement level. It means there is a high probability of a stock regaining its peak or trough.

Let us say, if a stock price appreciates to $210 from $160, there is a strong possibility of it to retrace back to $185 before rising again to $225 (reversal). With that said, there are many ways of using retracement, such as:

Identifying bullish and bearishBearishBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more market trendsEstimating potential reversal levels (support and resistance)Setting target price and stop loss for an assetPlacing buy or sell orders

It helps traders trade in the market when stocks rally sharply, and all they have to do is wait for retracement or correction to happen. After identifying Fibonacci levels (23.6%, 38.2%, and 61.8%), traders can decide whether to buy or sell that stock. For example, if a downtrend starts to go up, they can analyze the future market trend using the retracement level and decide when to sell an asset to get the best value.

In April 2021, the EUR/USD pair was discovered to have reached its all-time high. It was trading a bit more at 1.1976 than the moving averages and above the Fibonacci retracement level of 50%. The bulls calculated the retracement level at 61.8% and targeted it at 1.2040, causing the pair to rise in value further.

Also, it allows traders to identify bear trapsBear TrapsA bear trap is a technical stock trading pattern reflecting a misleading reversal of an upward trend in the financial market.read more and avoid being tricked by mature investors in the market. Overall, the Fibonacci retracement strategy prepares traders for the upcoming fluctuations in the market and allows them to trade safely in unpredictable market scenarios.