Fibonacci Retracement

| October 15, 2010 | 6 Comments

Fibonacci retracement (pronounced fib-on-arch-ee) is a very popular technical analysis tool. In fact, it’s a key tool that technical traders use, which makes it even more powerful since it becomes a self-fulfilling prophecy (the more people who use the tool, the more effective the tool will become).

Fibonacci retracement is based on the key numbers identified by Italian mathematician Leonardo Fibonacci in the 13th century. However, for the Fibonacci retracement tool, we aren’t as interested in the sequence of numbers as the mathematical relationships/ratios, between the numbers in the series. The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. Each number is simply the sum of the two preceding number, and the sequence continues infinitely in this sequence. What you might not know is that each number is approximately 1.618 times greater than the preceding number. This common relationship is what is used in Fibonacci retracement.

Essentially, these ratios are used to determine critical points that cause a trending stock’s price to reverse. Once there’s a retracement to these levels, we should see a continuation of the prior trend.

To use Fibonacci retracement, the best thing to do is to get a stock charting software that allows you to do so, because doing it manually would take up too much time and effort. The way to use Fibonacci retracement is to position the Fibonacci retracement sequence between two extreme points (usually a major peak and trough) on a stock chart. You should then see the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%, and these identify possible support and resistance levels.

As an example, the following chart of Jaya illustrates how Fibonacci retracement can be used. Notice how the price changes direction as it approaches the support/resistance levels.

jaya chart

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Category: Charting Patterns

About the Author ()

John Tan has been Vice President of BlueTrust Investments Corporation for 6 years since the mid-90’s. He has since moved on, to be a professional full-time trader.

Comments (6)

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  1. tay says:

    Ooo…is Fibonacci accurate?

    • ProfitFan says:

      It’s surprisingly accurate, but works best when entry is confirmed by other indicators (like how TA in general is)

  2. Leslie Lau says:

    thanks

  3. zaxk says:

    yes. especially when there is confluence of fib levels. both extension and retracement

  4. Den Ng says:

    So how does this come into place? Using how many years to guide? 1year 3 year, or 5 years?

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