Fibonacci Retracement Use
Raina Giorno
In finance, Fibonacci retracement is a method of technical analysis for determining support and resistance levels.[1] It is named after the Fibonacci sequence of numbers,[1] whose ratios provide price levels to which markets tend to retrace a portion of a move, before a trend continues in the original direction.
A Fibonacci retracement forecast is created by taking two extreme points on a chart and dividing the vertical distance by Fibonacci ratios. 0% is considered to be the start of the retracement, while 100% is a complete reversal to the original price before the move. Horizontal lines are drawn in the chart for these price levels to provide support and resistance levels. Common levels are 23.6%, 38.2%, 50%, and 61.8%. The significance of such levels, however, could not be confirmed by examining the data.[2] Arthur Merrill in Filtered Waves determined there is no reliably standard retracement.[3]
Fibonacci retracement is a popular tool that technical traders use to help identify strategic places for transactions, stop losses or target prices to help traders get in at a good price. The main idea behind the tool is the support and resistance values for a currency pair trend at which the most important breaks or bounces can appear.[4] The retracement concept is used in many indicators such as Tirone levels, Gartley patterns, Elliott wave principle, and more. After a significant movement in price (be it up or down) the new support and resistance levels are often at these lines.
Unlike moving averages, Fibonacci retracement levels are static prices. This allows quick and simple identification and allows traders and investors to react when price levels are tested. Because these levels are inflection points, traders expect some type of price action, either a break or a rejection. The 61.8% (0.618) Fibonacci retracement that is often used by financial analysts corresponds to the golden ratio.[1]
Extensive backtests of Fibonacci retracement over thousands of stocks have shown that the retracements values of 38%, 50%, and 62% had been no likelier to appear than any other of the possible retracement values.[3][5]
Now, the expectation is that if AUD/USD retraces from the recent high, it will find support at one of those Fibonacci retracement levels because traders will be placing buy orders at these levels as the price pulls back.
The expectation for a downtrend is that if the price retraces from this low, it could possibly encounter resistance at one of the Fibonacci levels because traders who want to play the downtrend at better prices may be ready with sell orders there.
If enough market participants believe that a retracement will occur near a Fibonacci retracement level and are waiting to open a position when the price reaches that level, then all those pending orders could impact the market price.
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In technical analysis, Fibonacci retracement levels indicate key areas where a stock may reverse or stall. Common ratios include 23.6%, 38.2%, and 50%, among others. Usually, these will occur between a high point and a low point for a security, designed to predict the future direction of its price movement.
As one of the most common technical trading strategies, a trader could use a Fibonacci retracement level to indicate where they would enter a trade. For instance, a trader notices that after significant momentum, a stock has declined 38.2%. As the stock begins to face an upward trend, they decide to enter the trade. Because the stock reached a Fibonacci level, it is deemed a good time to buy, with the trader speculating that the stock will then retrace, or recover, its recent losses.
Fibonacci retracements are trend lines drawn between two significant points, usually between absolute lows and absolute highs, plotted on a chart. Intersecting horizontal lines are placed at the Fibonacci levels.
Leonardo Fibonacci was a mathematician who worked on the "golden ratio" and developed the Fibonacci sequence. Many technical traders use what's known as a Fibonacci retracement to identify support and resistance price levels.
In the 1970s, some investors theorized that buying and selling in the stock market might follow patterns similar to those of a natural ecosystem. They began applying Fibonacci numbers to their charts in the form of Fibonacci retracements.
The 38.2% comes from dividing a number in the series by the number found two places to the right, and 23.6% comes from dividing a number by the number found three places to the right. The 50% level isn't really a Fibonacci number, but many traders still consider it a significant level.
To view these Fibonacci retracement levels, traders can access the Charts tab on the thinkorswim trading platform. After selecting a chart, the trader selects the time frame to analyze and then identify a high or low point. Select Drawings > Drawing Tools > % (Fibonacci Retracements) and place the cursor on the high or low point, click once, move to the next high or low point to the right, and click again. The tool automatically calculates the corresponding Fibonacci levels based on percentage retracements as seen below.
In the chart of the S&P 500 index (SPX) above, the top level is 100% and the bottom level is 0%. The retracement levels in between are areas traders can watch for potential technical support or resistance levels. Fibonacci retracements can also be used in the opposite way, from a low point to a high point (as long as the high point is to the right of the low one). In this scenario, retracing a move higher, the Fibonacci series frequently acts as key points of support in the pullback or correction.
When the SPX started to move above its March low, it met slight resistance at the 23.6% level. Even though it broke above it, the close was right around that level. The SPX then continued moving toward the 38.2% level, hesitated there for a few days, and then went back toward the 23.6% level. When reviewing the price chart, it's possible to see how the different retracement levels acted as support and resistance levels.
Fibonacci retracements are accepted and used by many traders, including some who trade for large institutions and hedge funds. There's no guarantee that using Fibonacci retracements will work effectively as part of a trading strategy, but they can provide some levels to watch when engaging in technical analysis.
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Interesting. This is a case where I think Tradovate does it correctly.
They draw from 0 to 100. From first click to last click.
TradingView does the same if you check the Reverse box.
Sounds like you guys want the tool to decide the direction for you?
Draw from bottom to top and you want it to display a counter from 100 to 0 so that the retracements mean 38.2 discount on price is the shallowest line, then 50%, then 61.8% etc. down to 100% discount at the bottom.
It makes sense logically, but everybody draws these things differently and thinks about price differently. I think perhaps just a reverse button like that TradingView does would make the most sense for everything. Thoughts?
I also want to comment that it is important to offer a line from the 100 to the 0. The ability to customize this line just like the others is welcome. I use that line all of the time. It is key when putting multiple fibs on the chart. The line from 100 to 0 will show the angle as well as the leg on which the fib is drawn. The angle of this line helps determine if the fib is being used for bullish or bearish retracements.
Stocks do NOT "follow Fibonacci retracement." Stocks move around randomly, together with some bias due to overall unpredictable market conditions. Sometimes these random movements correspond to a recognizable pattern on accident, and when they do people notice and say "look at that, a pattern!" Then they give these patterns fancy names like "Fibonacci retracement," and start looking for them in other places, which they will certainly find if they look hard enough. Sadly, any attempt to use these patterns in advance to predict future price movements fail. Sometimes they match on accident, and just as often they don't.
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