Fibonacci Retracement ExplainedWhat Are Fibonacci Retracement Levels?
In simple terms, Fibonacci Retracement Levels are horizontal lines on a chart that represent price levels. These price levels help identify where support or resistance may likely occur on a chart.
Each retracement level corresponds to a specific percentage, indicating how much of a pullback has taken place from a previous high or low. These percentages are derived from the Fibonacci sequence and include 23.6%, 38.2%, 61.8%, and 78.6%. Although not an official Fibonacci ratio, the 50% level is also commonly used.
This indicator is useful because it can be drawn between a high and a low price point, creating levels that indicate potential retracement areas between those two prices.
The basic Fibonacci Retracement amongst many trading platforms would normally look like this:
While this is okay, I would recommend changing the settings to my suggested format to improve clarity and comprehension. The revised version would look like this:
To copy this, the revised Fibonacci Retracement Settings are bellow:
By doing this, it shows you the “Golden Zone.” This spot is considered one of the most important areas because price often pulls back into this zone right before “extending” in a bullish pattern.
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Calculating Fibonacci Retracement Levels
The origin of the Fibonacci numbers is fascinating. They are based on something called the Golden Ratio.
This is a sequence of numbers starting with zero and one. Then, keep adding the prior two numbers to get the third number. This will eventually produce a number string looking like this:
• 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987...with the string continuing indefinitely.
Fibonacci retracement levels are derived from the Fibonacci number sequence. As the sequence progresses, dividing one number by the next number yields 0.618, or 61.8% (233 divided by 377 gives you 0.618037.
Divide a number by the second number to its right; the result is 0.382 or 38.2% (233 divided by 610 gives you 0.381967.
All these ratios, apart from 50% (which is not officially part of the Fibonacci sequence), are calculated based on relationships within this number sequence.
The golden ratio can be found in various places in nature as well. This includes spiral patterns of seashells (like nautilus shells), the arrangement of leaves on a plant stem, the petals of certain flowers, and the structure of pinecones; it's also often observed in art and architecture, such as in the proportions of the Mona Lisa and the Parthenon, where artists intentionally incorporated it for aesthetic appeal.
Now, as you can tell, the Fibonacci isn’t just some lines and numbers someone made up. It’s in everything you encounter. It’s on charts. It’s in nature. It’s in geometry. It’s even in HUMAN DNA.
Fibonacci Retracements vs. Fibonacci Extensions
Remember when I said, “price often pulls back into this zone right before extending in a bullish pattern.” ???
That’s because Fibonacci Retracement, sometimes confused with Fibonacci Extension, is the act of price level pulling back to the Golden Zone. The Fibonacci Extension is when price level continues to move in a bullish pattern after pulling back to the Golden Zone.
For example, if a stock goes from $10 to $20, then back to $13. The move from $20 to $13 is the retracement. If the price starts rallying again and goes to $30, that is the extension.
Limitations of Using Fibonacci Retracement Levels
While the retracement levels suggest potential areas for support or resistance, there’s no guarantee that the price will reverse to these levels. This is why traders often look for additional confirmation signals such as price action and patterns. A double bottom in this Golden Zone coupled with an RSI divergence is a very good indication the price will move after entering the Golden Zone.
!!!Fun Fact!!!
Fibonacci retracement levels were named after Italian mathematician Leonardo Pisano Bigollo, famously known as Leonardo Fibonacci. However, Fibonacci did not create the Fibonacci sequence. Instead, Fibonacci introduced these numbers to western Europe after learning about them from Indian merchants. Some scholars suggest Fibonacci retracement levels were formulated in ancient India between 700 BCE and 100 AD, while others estimate between 480-410 BCE.2
Cheers everyone!!! Happy Trading 😊
