What is Fibonacci Retracement: Meaning, Formula, Uses

Fibonacci retracements, which originate from the Fibonacci sequence, are horizontal lines indicating potential areas of support and resistance. A percentage is connected to each level. The percentage represents the amount of the price's retracement of a previous move. 

There are four Fibonacci retracement levels: 23.6%, 38.2%, 61.8%, and 78.6%. Even though it's not really a Fibonacci ratio, 50% is also employed. 

The indication may be created between any two important price points, such as a high and a low, making it handy. The ranges between those two spots will subsequently be created by the indicator.

Consider a stock whose price increases by Rs.10 before falling by Rs. 2.36. It has retraced 23.6% in that instance, which is a Fibonacci number. Natural events frequently use the Fibonacci numbers. As a result, many traders think that these metrics are also important in the stock markets.

The name of the Fibonacci retracement levels is derived from the work of the Italian mathematician Leonardo Pisano Bigollo, well known by his pen name Leonardo Fibonacci. Fibonacci, however, did not create the Fibonacci sequence. On the contrary, Fibonacci introduced these numbers to Western Europe after learning about them from Indian traders.

In the period between 450 and 200 BCE in ancient India, the Fibonacci retracement levels were developed. The Fibonacci numbers and the technique for sequencing them were most famously created by Indian mathematician Acarya Virahanka around 600 A.D.

Formula for Fibonacci Retracement Level 

The user chooses two points and then applies these indicators to a chart. The lines are drawn at percentages of that motion once those two spots have been selected.

Let's say the price increases from  Rs.10 to  Rs.15, and the points used to build the retracement indicator are these two price levels. In that case,  Rs.13.82 will represent the 23.6% level ( Rs.15 - ( Rs.5 0.236) =  Rs.13.82). At  Rs.12.50 ( Rs.15 - ( Rs.5 0.5) =  Rs.12.50), the 50% level will be reached.

Open Demat Account

Your first step to enter share market

Get Started

* By signing up you agree to our Terms and Conditions

Fibonacci Retracement Level Calculation

Fibonacci retracement levels are not calculable, as was previously mentioned. They are only percentages of the given price range. The Fibonacci numbers' history, however, is intriguing. The Golden Ratio serves as their foundation. A series of numbers should begin with 0 and 1. To obtain a string of integers like this, keep adding the first two digits:

The number sequence goes 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, and so on endlessly. 

From this series of numbers, the Fibonacci retracements are all derived. As the series progresses, the result of dividing one number by the following one is 0.618, or 61.8%. 

The answer is 0.382 or 38.2% when a number is divided by the next number to the right. Except for 50% (which is not a recognized Fibonacci number), all ratios are based on calculations employing this sequence of numbers.

It's intriguing to notice that the sequence may be observed in the development of pineapple fruitlets, tree branches, flower blooming patterns, and even the breeding habits of rabbits.

Why Use Fibonacci Retracement?

Fibonacci retracements may be used to create stop-loss boundaries, price goals, and entry orders. 

For example, a trader could see a stock increase. Before retracing to the 61.8% level, it ascends. After that, it keeps rising. Since the comeback occurred at a Fibonacci level during an upswing, the trader decides to buy. A return below that level may be a sign that the rally has failed, therefore the trader may put a stop loss at the 61.8% level.

In contrast to moving averages, the Fibonacci retracement remains constant. The pricing levels' unchanging nature makes identification quick and simple. This makes it easier for traders and investors to anticipate price level tests and respond wisely. 

These levels mark turning points when a price action of some kind, such as a break or a reversal, is anticipated. 

Shortcomings of Fibonacci Retracement 

The price may find support or resistance at the retracement levels, but there is no guarantee that the price will really stop there. This is why additional confirmation indications, such as the price beginning to bounce off the level, are frequently employed.

The fact that there are so many Fibonacci retracements means that the price is likely to reverse frequently around one of them, which is the second reason against them. The issue is that traders find it difficult to predict which one would be helpful at any given time. When things don't work out, one might always claim that the trader ought to have focused on a different Fibonacci retracement level.

Conclusion

In order to pinpoint probable levels of support and resistance in the financial markets, technical analysts employ the Fibonacci retracement. The Fibonacci sequence is a set of integers where each number is the sum of the two numbers before it. 

Fibonacci retracement levels are used by traders and investors to identify locations where the price of an asset is expected to decline or consolidate before moving forward in the general trend. 

Despite the fact that Fibonacci retracement is popular and largely regarded as a useful tool by traders, it is crucial to remember that it does not represent a guarantee of a price reversal or continuation. Technical analysts have access to a wide range of instruments, and this one's usefulness can change based on the state of the market and other variables.