Fibonacci retracement

DEFINITION of Fibonacci retracement

Fibonacci retracement is a method of technical analysis for determining support and resistance levels.

WHAT IT IS IN ESSENCE

They are named after their use of the Fibonacci sequence. The Fibonacci sequence is a set of numbers that start with a one or a zero. Then comes a one, and continues based on the rule that each number (called a Fibonacci number) is equal to the sum of the preceding two numbers.

Fibonacci retracement is starting from the idea that markets will retrace a predictable portion of a move. After which they will continue to move in the original direction.  

Arthur Merrill in Filtered Waves determined there is no reliable standard retracement: not 50%, 23.6%, 38.2%, 61.8%, nor any other.

The appearance of retracement can be visible to ordinary price volatility as described by Burton Malkiel. He was a Princeton economist.  In his book A Random Walk Down Wall Street, he found no reliable predictions in technical analysis methods taken as a whole.

Malkiel argues that asset prices typically exhibit signs of random walk. And that one cannot consistently outperform market averages.

HOW TO USE

Fibonacci retracement is a key technical analysis tool.  Traders use it to gain insight into when to place and close trades or place stops and limits. Like other Fibonacci analysis tools, Fibonacci retracements rely on the mathematical principle of the golden ratio. You can use it to find areas of support and resistance in major asset moves. Consequently, the point at which a move is halted before it continues past.

To calculate Fibonacci retracement levels, technical traders draw six lines across an asset’s price chart.

One at its highest point (known as 100%), other at its lowest point (0%).  The third is at its midpoint (50%). And then three at 61.8%, 38.2%, and 23.6% respectively.

According to the golden ratio, these should be points at which significant levels of support and resistance are met.

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