What Are Fibonacci Retracements?
Named after 13th-century mathematician, Leonardo Fibonacci, a Fibonacci Retracement is an indicator used in technical analysis that determines any Fibonacci relationships in an asset’s price fluctuations, by drawing support and resistance lines on a price chart. Fibonacci numbers (after their namesake) refer to a numbered sequence in which each number is the sum of the last two.
How Do Fibonacci Retracements Work?
A popular technical analysis tool, Fibonacci Retracements can help investors:
· Locate key levels of support and resistance
· Predict how far an asset’s price may move in a given direction
· Identify the best time to open a position
· Identify where to place stop loss and take profit levels
Fibonacci Retracement levels make use of horizontal lines that indicate areas of support and resistance and are created by drawing a trend line between the high and low points on a chart. The vertical distance between the two points is then divided by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%, with a horizontal line drawn at each location.
How Do I Trade Using Fibonacci Retracements?
It is important to note that Fibonacci Retracements work best during trending market conditions.
During an uptrend, the retracement levels will be created by drawing a trend line from the most recent low to the most recent high. They can then be used by investors as signals to buy. This is based on the expectation that, if the price were to retrace lower from the recent high, it would find support at one of the levels and bounce back higher.
During a downtrend, the retracement levels are created by drawing a trend line from the most recent high to the most recent low. They could then be used by investors as signals to sell. This is based on the expectation that, if the price were to retrace higher from the recent low, it would encounter resistance at one of the Fibonacci Retracement levels and bounce back lower.
Although Fibonacci Retracements can be a powerful tool in the hands of experienced investors, they are best used in conjunction with other technical indicators. For example, they can be combined with a momentum indicator such as the MACD
or the Stochastic Oscillator to help identify the best time to open a position.