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Method of Operation2

Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur based on Fibonacci ratios of a prior price move. The most commonly used ratios are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. While Fibonacci retracements were named after Leonardo Fibonacci, the underlying sequence and its use in mathematics was first developed by Indian mathematicians centuries earlier.

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25 views7 pages

Method of Operation2

Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur based on Fibonacci ratios of a prior price move. The most commonly used ratios are 23.6%, 38.2%, 50%, 61.8%, and 78.6%. While Fibonacci retracements were named after Leonardo Fibonacci, the underlying sequence and its use in mathematics was first developed by Indian mathematicians centuries earlier.

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Fibonacci Retracement Levels

What Are Fibonacci Retracement Levels, and What Do


They Tell You?

What Are Fibonacci Retracement Levels?

Fibonacci retracement levels ,also named golden


section retracement levels —stemming from the
Fibonacci sequence—are horizontal lines that indicate
where support and resistance are likely to occur.

Each level is associated with a percentage. The


percentage is how much of a prior move the price has
retraced. The Fibonacci retracement levels are 23.6%,
38.2%, 61.8%, and 78.6%. While not officially a
Fibonacci ratio, 50% is also used.

The indicator is useful because it can be drawn between


any two significant price points, such as a high and a
low. The indicator will then create the levels between
those two points.
Suppose the price of a stock rises $10 and then drops
$2.36. In that case, it has retraced 23.6%, which is a
Fibonacci number. Fibonacci numbers are found
throughout nature. Therefore, many traders believe
that these numbers also have relevance in financial
markets.

Fibonacci retracement levels were named after Italian


mathematician Leonardo Pisano Bigollo, who was
famously known as Leonardo Fibonacci. However,
Fibonacci did not create the Fibonacci sequence.
Instead, Fibonacci introduced these numbers to
western Europe after learning about them from Indian
merchants.

Fibonacci retracement levels were formulated in


ancient India between 450 and 200 BCE.

KEY TAKEAWAYS

 Fibonacci retracement levels connect any two


points that the trader views as relevant, typically a
high point and a low point.
 The percentage levels provided are areas where
the price could stall or reverse.
 The most commonly used ratios include 23.6%,
38.2%, 50%, 61.8%, and 78.6%.
 These levels should not be relied on exclusively, so
it is dangerous to assume that the price will reverse
after hitting a specific Fibonacci level.
 Fibonacci numbers and sequencing were first used
by Indian mathematicians centuries before
Leonardo Fibonacci.

Numbers First Formulated in Ancient India

Despite its name, the Fibonacci sequence was not


developed by its namesake. Instead, centuries before
Leonardo Fibonacci shared it with western Europe, it
was developed and used by Indian mathematicians.

Most notably, Indian mathematician Acarya Virahanka


is known to have developed Fibonacci numbers and the
method of their sequencing around 600 A.D. Following
Virahanka’s discovery, other subsequent generations of
Indian mathematicians—Gopala, Hemacandra, and
Narayana Pandita—referenced the numbers and
method. Pandita expanded its use by drawing a
correlation between the Fibonacci numbers and
multinomial co-efficients.

It is estimated that Fibonacci numbers existed in Indian


society as early as 200 B.C.

The Formula for Fibonacci Retracement Levels

Fibonacci retracement levels do not have formulas.


When these indicators are applied to a chart, the user
chooses two points. Once those two points are chosen,
the lines are drawn at percentages of that move.

Suppose the price rises from $10 to $15, and these two
price levels are the points used to draw the retracement
indicator. Then, the 23.6% level will be at $13.82 ($15 -
($5 × 0.236) = $13.82). The 50% level will be at $12.50
($15 - ($5 × 0.5) = $12.50).

How to Calculate Fibonacci Retracement Levels


As discussed above, there is nothing to calculate when it
comes to Fibonacci retracement levels. They are simply
percentages of whatever price range is chosen.

However, the origin of the Fibonacci numbers is


fascinating. They are based on something called
the Golden Ratio. Start a sequence of numbers with
zero and one. Then, keep adding the prior two numbers
to get a number string like this:

 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377,


610, 987...with the string continuing indefinitely.

The Fibonacci retracement levels are all derived from


this number string. After the sequence gets going,
dividing one number by the next number yields 0.618,
or 61.8%. Divide a number by the second number to its
right, and the result is 0.382 or 38.2%. All the ratios,
except for 50% (since it is not an official Fibonacci
number), are based on some mathematical calculation
involving this number string.

What Do Fibonacci Retracement Levels Tell You?


Fibonacci retracements can be used to place entry
orders, determine stop-loss levels, or set price targets.
For example, a trader may see a stock moving higher.
After a move up, it retraces to the 61.8% level. Then, it
starts to go up again. Since the bounce occurred at a
Fibonacci level during an uptrend, the trader decides to
buy. The trader might set a stop loss at the 61.8% level,
as a return below that level could indicate that the rally
has failed.

How do you draw a Fibonacci retracement?

Fibonacci retracements are trend lines drawn between


two significant points, usually between absolute lows
and absolute highs, plotted on a chart. Intersecting
horizontal lines are placed at the Fibonacci levels.

The Bottom Line

Fibonacci retracements are useful tools that help


traders identify support and resistance levels. With the
information gathered, traders can place orders, identify
stop-loss levels, and set price targets. Although
Fibonacci retracements are useful, traders often use
other indicators to make more accurate assessments of
trends and make better trading decisions.

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