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.)

[ Fibonacci retracement is a popular technical indicator that can become even more powerful when used in conjunction with other indicators. If you want to learn more about this as well as how to transform patterns into actionable trading plans, Investopedia Academy's technical analysis course is a great start. ]

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 the 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 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. What are the main advantages of using Fibonacci Retracements for trading strategies?

    Read about some of the advantages of the Fibonacci trading system and how retracements can be applied to any instrument to ... Read Answer >>
Related Articles
  1. Trading

    Using a Fibonacci Retracement

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

    Top 4 Fibonacci Retracement Mistakes To Avoid

    Using Fibonacci incorrectly can have disastrous consequences. Find out which common moves to avoid.
  4. Trading

    Advanced Fibonacci Applications

    Extensions, clusters, channels and more! Discover new ways to put the "golden ratio" to work.
  5. 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.
  6. Trading

    3 Fibonacci Trades For Late Summer

    Fibonacci retracement analysis organizes chaotic price action, highlighting hidden buying and selling opportunities.
  7. Trading

    What You Can Learn From the Latest Bitcoin Panic

    This is not the first time the price of Bitcoin has tanked.
  8. Trading

    Retracement or Reversal: Know the Difference

    Learn to distinguish between a temporary price change and a long-term trend.
  9. Trading

    3 Technical Tools To Improve Your Trading

    Find out how volume, the Aroon indicator and Fibonacci numbers can improve your profits.
  10. Trading

    High-Tech Fibonacci

    Fibonacci developed this system in the Middle Ages. See how it can provide accuracy without sacrificing readability.
RELATED TERMS
  1. Fibonacci Time Zones

    An indicator used by technical traders to identify periods in ...
  2. Fibonacci Numbers/Lines

    Leonardo Fibonacci was an Italian mathematician born in the 12th ...
  3. Fibonacci Clusters

    A tool used in technical analysis that combines various numbers ...
  4. Retracement

    A temporary reversal in the direction of a stock's price that ...
  5. Fibonacci Arc

    A charting technique consisting of three curved lines that are ...
  6. Gartley Pattern

    In technical analysis, it is a complex price pattern based on ...
Hot Definitions
  1. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  2. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  3. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  4. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  5. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  6. Absolute Advantage

    The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost ...
Trading Center