Fibonacci Retracements are ratios used to identify potential reversal levels. Trader’s use these to predict where support or resistance levels are. The most popular Fibonacci Retracements are 61.8% and 38.2%.
Fibonacci numbers were identified by Leonardo Fibonacci, represent ratios that naturally occurred in Nature. Fibonacci numbers are simply a series of numbers that when you add the previous two numbers you come up with the next number in the sequence. Here is an example: 1, 2, 3, 5, 8, 13, 21, 34, 55
1 + 2 = 3; 2 + 3 = 5;
The main ratio also known as the Golden Ratio or PHI is 1.618 or the inverse 0.618. (calculated: number divided by the previous number approximates 1.618 55/34 = 1.618 or the other way round 34/55 = 0.618). Fibonacci numbers occur in nature and in the various markets as Forex, Stocks, Indices and commodities. There are many tools that incorporate the Fibonacci levels:
- Fibonacci Retracements
- Fibonacci Arcs
- Fibonacci Fans
- Fibonacci Time Extensions
Fibonacci Retracements
The Fibonacci retracement tool is the most popular tool used applying the Fibonacci levels. To use the tool, just place the high and low on the highest point and the lowest point of the move, with the 0 at the extreme point of the move. The Fibonacci retracement tool will then project the retracement levels, as you can see in the spread betting example above.
In the graph above of the Spread betting index FTSE 100, you can see various levels projected which have become resistance while the FTSE was retracing it’s downward movement. Here is a spread betting strategy where the resistance areas where the FTSE Index stalled and retraced and presented itself as good trading opportunities are: 23.6% to 38.2% to a strong 50% then to 61.8%.
Once one resistance broke, this level then becomes support. Note in the spread betting example how 23.6% was initially resistance then became support, the same with the 50% level which became support and 61.8% resistance.
Next: Fibonacci Arcs