In this article, we will discuss
- What is Fibonacci Retracement?
- How Does Fibonacci Retracement Work in Financial Markets?
- What Are the Fibonacci Levels?
- Example to Calculate Fibonacci Retracement Levels
When you analyse the market as a trader, you use various strategies and methods to find the worthwhile opportunities and patterns. Fibonacci Retracement is one such method that traders levy to identify the support and resistance levels of a stock. For those who don’t know, Fibonacci is a numerical series where every number in the sequence is the sum of the last two numbers. E.g.: 1, 1, 2, 3, 5, 8, 13 is a Fibonacci sequence.
Now if you are wondering how a series of numbers can help you choose a stock, this blog is just for you. Keep reading!
What is Fibonacci Retracement?
Fibonacci retracement is a derivation from the original Fibonacci sequence. It involves drawing horizontal lines on a price chart that indicate the support and resistance level of a stock. These lines are drawn between the high and low price points of an asset. These points are mainly indicators of moments where the price of an asset might either reverse its trend or simply just hold.
If you observe a Fibonacci sequence closely, you will realise that every number is approximately 1.618 times higher than the number preceding it. This number, which is actually Phi, is also known as the golden ratio. By using this ratio and the sequence together, intraday traders can determine pullback and impulses on the price chart of a stock.
How Does Fibonacci Retracement Work in Financial Markets?
Now that you know how the sequence is formed, there are some noteworthy relationships between each of these numbers. It is important for traders to understand some of these relationships to understand how it is used for price analysis.
- If you divide any number on this sequence by its preceding number, the result will always be approximately 1.618.
- If you divide a number on the sequence with its immediately succeeding number, the result will always be 0.618. If you convert it into a percentage, the resulting figure comes to around 61.8%.
- If you divide a number on this sequence by a number that is two places up the given number, the answer would be 0.382. Expressing it in percentage would bring it to 38.2%
- Finally, if you divide a number on this sequence with a number that is three places higher than the number, your answer would be 0.236. On expressing it in percentage, the answer would be 23.6%.
What Are the Fibonacci Levels?
Levels in Fibonacci retracement depict a percentage representation of how much the price retraced before it moved further ahead. For example, if the price of a stock increases from ₹100 to ₹ 110, it won’t make a straight dive from 100 to 110. It might first go down to ₹90 before bouncing back up and touching 110. This percentage of retracement is what we represent through Fibonacci levels.
The first level in this sequence is 23.6%, then followed by 38.2% and then 61.8% and finally 78.6%. Now you will understand how the retracement is related to this sequence. Even though 50% doesn’t fall in this sequence, your software might also trace the 50% level while drawing the horizontal lines at different levels.
Example to Calculate Fibonacci Retracement Levels
Let’s say the price of a stock increased from ₹2000 to ₹3000. Now if you want to identify different levels as per Fibonacci series, then the calculator would be as follows:
3000 - (1000*23.6%) = ₹2,764.
Hence, the first level of your Fibonacci retracement line should be at ₹2,764.
Now using this formula, you can draw all four levels of retracement on the price chart. If you analyse it on your software, it might also add the 50% level, making it an additional line. For price analysis purposes, you need to mark two price points between which you want to make the analysis.
Now if you notice that a stock price is rising upwards and it has retraced to a Fibonacci level, it might mean that the stock shall continue to uphold the trend.
Fibonacci sequence is present in many places in nature and life around us. It is because of its presence in so many objects that experts believe it could also be present in the stock markets as well.
Due to the ease of the technique, Fibonacci retracement is considered a great trading tool for novice investors. You can start implementing it as a part of your technical analysis to pick the right stocks.
Frequently Asked Questions
Q1. Who discovered the Fibonacci sequence?
Ans. Origin of the Fibonacci sequence dates back to ancient Indian mathematics scripts. However, many believe that Italian mathematician Leonardo Pisano discovered it in the 12th century. Since he was called Fibonacci by his friends, the sequence got the same name.
Q2. Is Fibonacci Sequence an absolute indicator of a trend?
Ans. Fibonacci sequence is a great trading tool for novice investors. However, it is not an absolute indicator, and you should not use it alone. You will have to employ the use of other technical methods for more accurate analysis.
Q3. Do I need to draw Fibonacci levels every time I want to analyse the market?
Ans. Most software come with an inbuilt feature, so you don't need to manually draw the levels or calculate them. Once you choose the price points and select the Fibonacci option, the software will do it for you.
Q4. What are some famous examples where we can find the Golden ratio?
Ans. Some of the most common examples where we can find the Golden Ratio include human faces, rose petals and even the pyramid of Giza.
Q5. How do I choose the price points for Fibonacci analysis?
Ans. The price points should be the latest high and low on the price chart. This is also called identifying the 100% mark.
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