Loading the player...
A:

Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. However, Fibonacci's sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. In technical analysis, Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels. Before we can understand why these ratios were chosen, we need to have a better understanding of the Fibonacci number series. (For a more in-depth discussion of this subject, see Fibonacci And The Golden Ratio.)

The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms and sequence continues infinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies.

The key Fibonacci ratio of 61.8% - also referred to as "the golden ratio" or "the golden mean" - is found by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.

The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 55/144 = 0.3819.

The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example: 8/34 = 0.2352.

For reasons that are unclear, these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset's price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above. The following chart illustrates how Fibonacci retracement can be used. Notice how the price changes direction as it approaches the support/resistance levels.

FibRetracement.gif

In addition to the ratios described above, many traders also like using the 50% and 78.6% levels. The 50% retracement level is not really a Fibonacci ratio, but it is used because of the overwhelming tendency for an asset to continue in a certain direction once it completes a 50% retracement. (To learn more about the various tools used in technical analysis, see our Technical Analysis tutorial.)

RELATED FAQS
  1. What are the alert zones in a Fibonacci retracement?

    Discover more about the Fibonacci number sequence, and specifically about the key Fibonacci retracement alert levels most ... Read Answer >>
  2. What are some of the more common Fibonacci retracements?

    Examine the basic Fibonacci retracement levels, and learn how key Fibonacci levels are used by traders to identify potential ... Read Answer >>
  3. What are the main disadvantages of using Fibonacci Retracements for trading strategies?

    Learn about the disadvantages inherent to the Fibonacci retracement, an indicator built on the Fibonacci sequence used in ... Read Answer >>
  4. Why is the Fibonacci Retracement important for traders and analysts?

    Find out why traders and analysts in financial markets use Fibonacci retracement to help identify support and resistance ... Read Answer >>
  5. How can a swing trader use a Fibonacci retracement?

    Learn how swing traders can use Fibonacci retracements to identify areas of support and resistance, as well as entry and ... Read Answer >>
  6. What are the most common strategies to place retracement levels?

    Find out how traders place Fibonacci retracement levels, and learn what it means when a price retracement seems to reverse ... Read Answer >>
Related Articles
  1. Markets

    Using a Fibonacci Retracement

    The Fibonacci retracement is the potential retracement of a financial asset's original move in price.
  2. Trading

    Fibonacci And The Golden Ratio

    Discover how this amazing ratio, revealed in countless proportions throughout nature, applies to the financial markets.
  3. Trading

    Top 4 Fibonacci Retracement Mistakes To Avoid

    There are common mistakes traders make when applying Fibonacci retracements to foreign exchange markets. Here are four well-known errors to avoid.
  4. Trading

    Fibonacci: Using Math To Make Right Market Moves

    Use these two original Fibonacci techniques to pinpoint the patterns in stock movements, and the most reliable entry and exit levels.
  5. Markets

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  6. Trading

    How To Use Fibonacci To Trade Forex

    Fibonacci offers a perfect fit with forex strategies, locating hidden support and resistance levels that translate into high odds entry and exit prices.
  7. Markets

    Stocks Trading at the 61.8% Pullback Level (TSLA,NAVI)

    Here are stocks trading the 61.8% Fibonacci retracement level, and how to trade them (and this recurring pattern).
  8. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  9. Trading

    4 Simple Investing Ratios You Need To Know

    Dissecting a company’s financial statements to uncover ways to make money is a challenging endeavor. Here are four ratios that can help.
  10. Markets

    Using Fibonacci to Analyze Gold (GLD, GC)

    Use Fibonacci studies to analyze gold by picking out hidden harmonic levels that can provide major support or resistance.
RELATED TERMS
  1. Fibonacci Time Zones

    An indicator used by technical traders to identify periods in ...
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support ...
  3. Fibonacci Fan

    A charting technique consisting of three diagonal lines that ...
  4. Fibonacci Clusters

    A tool used in technical analysis that combines various numbers ...
  5. Fibonacci Channel

    A variation of the Fibonacci retracement pattern in which the ...
  6. Fibonacci Extensions

    Levels used in Fibonacci retracement to forecast areas of support ...
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center