Fibonacci Retracement – How it works, How to use it, Example & more

Fibonacci Retracement is a technical indicator used by top technical analyst. This is derived from Fibonacci numbers or sequence which helps in determining the support and resistance levels

Lets get started with this fascinating technical analysis tool.

What is Fibonacci Retracement?

In order to have a clear idea about Fibonacci Retracements, the user must have an understanding of the Series.

This sequence came into existence very early, that is, in the 6th century AD. It came into light with a discovery by Indian mathematicians.

Nevertheless, it was introduced in the west by Fibonacci, who we also recognize as Leonardo Bonacci. In mathematics, we generally denote the series with F (0).

It is a series of numbers that start from 0 (zero) and are in a manner that any number from the series is equal to the results of the last two numbers from the series.

The first two terms of the series are 0 and 1 by convention. When it comes to the Fibonacci sequence, one can notice that,

21 = 13 + 8

233 = 144 + 89

987 = 610 + 377

The series, however, ends to infinity. There’s something special about the Fibonacci Series.

By dividing any number of the series from the previous number, one will always get an approximate value of 1.618.

Further Explanation on Fibonacci Retracements

Here are few examples which can help you understand how Fibonacci retracement works.

21/13 = 1.618

55/34 = 1.618

144/89 = 1.618

This ratio is what we call the Golden Ratio. We know it as Phi. The experts believe that these numbers have a sort of connection to the planet.

Further, when one divides a Fibonacci number with its succeeding number, one always gets a constant number, that is, 0.618.

For Example:

5/8 = 0.618

13/21 = 0.618

34/55 = 0.618

In case we try to represent it as a percentage, it is 61.8 percentage.

We can find the same when we divide a number from the Series by a number that is 2 places higher than that.

For Example,

2/5 = 0.318

5/13 = 0.318

13/34 = 0.318

In case it is represented as a percentage, it is 31.8%.

We can find the same when we divide a number from the Fibonacci Series by a number that is 3 places higher than that.

For Example:

1/3 = 0.236

2/8 = 0.236

13/55 = 0.236

21/89 = 0.236

In case we try to represent it as a percentage, it is 23.6%.

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    Relevance of Fibonacci Ratios to Stock Markets

    Fibonacci analysis is something that we can implement when we see a detectable change in prices. The change can either be a shift up or a shift down.

    It has been observed that whenever there is a sharp rise or a sharp fall, the stock tends to backtrack before it goes back up or down again.

    For instance, if the price of the stock has gone up from INR 80 to INR 160, then chances are that it may backtrack to almost INR 100 before it can go up again to INR 180.

    There is a technique, known as ‘The retracement level prediction’. A person can use this in order to trace the level up to which the retracement is bound to happen.

    These levels of retracement give a very good chance for the investors to search and set foot in new spots in the line of the trend.

    The ratios, that is, 61.8%, 38.2%, 23.6% aid the investors to look for the practicable level up to which the retracement can happen. The investor can position himself according to these levels.

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    How Fibonacci Retracement Works?

    We will understand it with the help of an example.

    A stock is priced at INR 350 and it goes up to INR 450. The shift up of INR 100 is known as Fibonacci up-move.

    Considering the Retracement Theory, after the shift up has happened, one can possibly predict a rectification in the stock.

    The prediction is that the stock would follow Fibonacci Ratios.

    Let us consider, the first level would be 23.6%. In case it continues to go up, investors can notice it going up to 38.2% and then 61.8% extents.

    Now, the total up-move is INR 100.

    61.8% up-move = 61.8 * 100 = INR 61.80.

    Retracement at 61.8% = INR 450 – INR 61.8 = INR 388.20.

    Fibonacci Retracement – Movement against the Trend

    The movement against the trends here is called a Fibonacci retracement. In order to utilize the Fibonacci retracements, one needs to trace the 100% Fibonacci move in the first step.

    Fibonacci Retracement Levels

    That 100% move can either be a shift up or a shift down. In order to trace the 100% Fibonacci move, one needs to choose the latest peak and trough which is shown on a chart.

    Once that is pointed out, one can easily join them with the help of a retracement tool. One can also refer to the following guide that details the procedure step by step.

    • The first step s to trace the latest peak and trough.
    • The second step is to select the retracement tool.
    • Using the Retracement Tool, connect the peaks and the troughs.
    • After the trader has selected the tool, he needs to tap on the trough initially, and he does not have to tap it. Rather, he has to drag it till the peak. Also, the software retraces it only after the process of connecting all the troughs and peaks has been completed.

    How to use Fibonacci Ratios Concept?

    There have been certain situations and circumstances where no matter how much a trader wanted to purchase a specific stock; he couldn’t due to a shift up in the stock.

    In case someone is stuck in a similar situation, they need to wait for the perfect situation when the stock would retrace back.

    The retracement levels are about the stock acting to a potential level of improvement and it is for the expert traders to understand.

    By representing these particular retracement levels on the graph, the trader can trace these levels, and consequently, position himself in order to grab the space to go into the trade.

    Just like any other indicator, the Fibonacci retracement acts as a tool. However, one’s stance to purchase would be greater in case the stock has:

    • Made an identifiable candlestick design.
    • The stop loss clashes with the S&R level
    • The volumes are surpassing average.

    Fibonacci Retracement – Conclusion

    • The series can be the fundamental Concept for a complete retracement procedure and in order for the trader to understand the retracement levels, it is vital to understand how this series works.
    • We can see that this series will have a lot of mathematical interference in itself. These properties, as the experts say, connect to nature and its balance itself.
    • The traders and investors believe that this series will have particular implementations when it comes to stock charts. It happens because many traders are able to actually trace the retracement level with the help of this presentation.
    • The retracement can work on multiple extensive before it gets back to an original position. As discussed earlier, the extent could either be 61.8, 38.2, 23.6 accordingly.
    • When we see at the retracement level, the trader can lookout for a new trade. Especially, in these cases, he should authenticate the rest of the points present on the checklist. Overall, it is mandatory to have a basic understanding of this concept before proceeding any further.

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