Fibonacci Levels

What Are Fibonacci Retracement Levels?

Fibonacci retracement levels are lines on a chart that show where a stock's price might find support or resistance. The levels are based on percentages derived from the Fibonacci sequence, which is a series of numbers found in nature. The Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 78.6%.

These levels can be drawn between any two significant price points on a chart. For example, if a stock rises by $10 and then falls by $2.36, it has retraced 23.6%, which is one of the Fibonacci numbers. The indicator is named after an Italian mathematician named Leonardo Fibonacci, who learned about the sequence from Indian merchants. The levels were formulated in ancient India between 450 and 200 BCE.

While the Fibonacci retracement levels are not always perfect indicators of support and resistance, many traders use them to help make trading decisions. They can be a useful tool for identifying potential entry and exit points, and for setting stop-loss orders to manage risk.

KEY TAKEAWAYS

• Fibonacci retracement levels connect any two points that the trader views as relevant, typically a high point and a low point.

• The percentage levels provided are areas where the price could stall or reverse.

• The most commonly used ratios include 23.6%, 38.2%, 50%, 61.8%, and 78.6%.

• These levels should not be relied on exclusively, so it is dangerous to assume that the price will reverse after hitting a specific Fibonacci level.

• Fibonacci numbers and sequencing were first used by Indian mathematicians centuries before Leonardo Fibonacci.

How to Calculate Fibonacci Retracement Levels

As discussed above, there is nothing to calculate when it comes to Fibonacci Retracement Levels. They are simply percentages of whatever price range is chosen.

However, the origin of the Fibonacci numbers is fascinating. They are based on something called the Golden Ratio. Start a sequence of numbers with zero and one. Then, keep adding the prior two numbers to get a number string like this:

• 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987... with the string continuing indefinitely

The Fibonacci retracement levels are all derived from this number string. After the sequence gets going, dividing one number by the next number yields 0.618, or 61.8%. Divide a number by the second number to its right, and the result is 0.382 or 38.2%. All the ratios, except for 50% (since it is not an official Fibonacci number), are based on some mathematical calculation involving this number string.

What is the "Golden Pocket"?

The Golden Pocket is a term that refers to a specific zone within the Fibonacci retracement levels. It is considered a highly significant support or resistance level when analyzing price movements in financial markets.

The Golden Pocket is located between the 61.8% and 65% Fibonacci retracement levels. These levels are derived from the Fibonacci sequence, a series of numbers where each number is the sum of the two preceding ones, starting from 0 and 1 (0, 1, 1, 2, 3, 5, 8, 13, ...). The ratio between consecutive Fibonacci numbers converges to the golden ratio (approximately 1.618), which is found in many natural and man-made structures.

In trading, the Golden Pocket is considered a crucial zone because it often acts as strong support during an uptrend or as resistance during a downtrend. Prices frequently reverse or bounce off this zone, making it an essential area for traders to watch for potential trade setups.

For example, if the price of an asset is in a downtrend and reaches the Golden Pocket zone (61.8% to 65% retracement of the prior upswing), traders might look for buying opportunities, expecting the price to bounce off this support level. Conversely, in an uptrend, traders might look for selling opportunities when the price reaches the Golden Pocket, anticipating resistance and a potential reversal or retracement.

What Do Fibonacci Retracement Levels Tell You?

Fibonacci retracements help traders determine where to buy or sell stocks. The levels are based on the Fibonacci sequence, and are static, meaning they don't change. They can be used to set entry orders, stop-loss levels, or price targets. If the stock price moves up and retraces to the 61.8% level, a trader might buy since it bounced off a Fibonacci level during an uptrend.

Fibonacci levels can also be used in other technical analysis, such as Gartley patterns and Elliott Wave theory. These methods suggest that reversals tend to occur close to certain Fibonacci levels. Since the levels are static, they can be quickly identified, and traders can anticipate how the price will react when tested. Fibonacci retracements are inflection points where some kind of price action is expected, either a reversal or a break.

Fibonacci Retracements vs. Fibonacci Extensions

Fibonacci extensions are similar to retracements but instead of applying percentages to a pullback, they apply percentages to a move in the trending direction. Suppose a stock rises from $5 to $10, then falls back to $7.50. The fall from $10 to $7.50 is a retracement. If the price starts rising again and goes to $16, that is an extension. Fibonacci extensions are useful for traders who want to set profit targets for a trending stock. The levels to watch for extensions are 0.618, 1.000, 1.272, 1.618, 2.000, and 2.618.

Limitations of Using Fibonacci Retracement Levels

Although Fibonacci retracement levels provide an idea of where the price may face support or resistance, it is not guaranteed that the price will stop there. Therefore, traders often use other confirmation signals, such as price bouncing off the level, to make decisions.

On the other hand, some traders criticize the abundance of Fibonacci retracement levels, making it challenging to determine which one to use. Traders may end up using the wrong level, leading to unsuccessful trades, and then claim that they should have used another Fibonacci level.

Summary

Fibonacci retracements are a helpful resource for traders to spot crucial support and resistance levels. This data can be used to put in orders, establish stop-loss levels, and set price targets. Although Fibonacci retracements can be useful, traders commonly use other indicators to create more precise evaluations of trends and make better decisions in trading.