Fibonacci Retracement: A Method of Technical Analysis in Stock Trading

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A Fibonacci retracement is a popular tool among technical traders and is based on some key numbers. The origins of the Fibonacci series can be traced back to the ancient Indian mathematic scripts, with some claims dating back to 200 BC. However – in the 12th century – Leonardo Pisano Bigollo, an Italian mathematician who was known to his friends as Fibonacci, discovered Fibonacci numbers.

It is a popular tool that technical traders use to help identify price levels for transactions, stop losses or target prices. These retracement levels also provide support and resistance levels for a stock. However, it really becomes most effective when confirming signals or conditions identified by additional technical analysis tools.

Retracement levels alert traders or investors of a potential trend reversal, resistance area or support area. Retracements are based on the prior move. A bounce is expected to retrace a portion of the prior decline, while a correction is expected to retrace a portion of the prior advance. Once a pullback starts, chartists can identify specific Fibonacci retracement levels for monitoring. As the correction approaches these retracements, chartists should become more alert for a potential bullish reversal. Chart 1 shows Home Depot retracing around 50% of its prior advance.

The inverse applies to a bounce or corrective advance after a decline. Once a bounce begins, chartists can identify specific Fibonacci retracement levels for monitoring. As the correction approaches these retracements, chartists should become more alert for a potential bearish reversal

Fibonacci Retracements are ratios used to identify potential reversal levels, and the most popular Fibonacci Retracements are 61.8 percent and 38.2 percent.

For reasons that are unclear, these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset’s price to reverse

The Fibonacci retracement tool plots percentage retracement lines based upon the mathematical relationship within the Fibonacci sequence series. These retracements can be combined with other indicators and price patterns to create an overall strategy. 

Remember that trading is all about probabilities. If you stick to those higher probability trades, then there’s a better chance of coming out ahead in the long run.