Fibonacci retracement is named after the 13th century mathematician Leonard Fibonacci, who developed a series of numbers that contain ratios that have proved important in technical analysis of the stock market. Fibonacci’s original sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Certain repeating ratios exist within these numbers. For instance, the ratio of approximately 61.8%, called the “Golden Ratio”, is created by dividing one number by the number that follows: 8/13 = 61.53%, 34/55 = 61.81%, etc.
The key Fibonacci retracement ratios used by technical analysts are 23.6%, 38.2%, 50%, 61.8% and 100%. Although the reasons why are uncertain, a stock’s trend tends to retrace a prior trend once its price hits one of the key Fibonacci retracement ratio points.
Traders take advantage of the trend behavior indicated by the Fibonacci retracement analysis to determine the best time to buy or sell securities.
For instance, if a stock’s price hit the 38.2% point, and then started to trend downwards, a trader using this analysis will expect the stock to start trending back upwards after the price falls to the 23.6% point. He will set a buy order to purchase it at the 23.6% point so that he can take advantage of an anticipated upward trend.