Introduction
Fibonacci retracement is a technical analysis tool used to identify potential levels of support and resistance in a financial market. It is based on the idea that price movements in a market follow a sequence of numbers discovered by Leonardo Fibonacci in the 13th century. In this article, we will discuss how to calculate Fibonacci retracement levels and how to use them in trading.
What is Fibonacci Retracement?
Fibonacci retracement is a method of identifying levels of support and resistance in a financial market. It is based on the Fibonacci sequence, a series of numbers in which each number is the sum of the two preceding ones. The sequence goes like this: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on.
How to Calculate Fibonacci Retracement Levels?
To calculate Fibonacci retracement levels, you need to identify the high and low points of a price movement in a financial market. Once you have identified these points, you can use the following formula to calculate the retracement levels: Retracement level = (High – Low) x Fibonacci level + Low The Fibonacci levels used in the formula are typically 0.236, 0.382, 0.50, 0.618, and 0.786. These levels are derived from the Fibonacci sequence.
How to Use Fibonacci Retracement in Trading?
Fibonacci retracement levels can be used in trading to identify potential levels of support and resistance. When a market is trending upwards, traders can use Fibonacci retracement levels to identify potential levels of support where the price might bounce back up. When a market is trending downwards, traders can use Fibonacci retracement levels to identify potential levels of resistance where the price might bounce back down.
Examples of Fibonacci Retracement in Trading
Let’s take an example of how Fibonacci retracement levels can be used in trading. Suppose the price of a stock has been trending upwards and has reached a high of $100. The low of the price movement was $80. We can use Fibonacci retracement levels to identify potential levels of support if the price retraces back down. Using the formula we discussed earlier, we can calculate the retracement levels as follows: – 0.236 retracement level = (100 – 80) x 0.236 + 80 = $89.28 – 0.382 retracement level = (100 – 80) x 0.382 + 80 = $86.56 – 0.50 retracement level = (100 – 80) x 0.50 + 80 = $90.00 – 0.618 retracement level = (100 – 80) x 0.618 + 80 = $93.44 – 0.786 retracement level = (100 – 80) x 0.786 + 80 = $97.92 These levels can be used as potential levels of support if the price retraces back down.
Conclusion
Fibonacci retracement is a powerful tool that can be used to identify potential levels of support and resistance in a financial market. By using Fibonacci retracement levels, traders can make informed decisions about when to buy or sell a financial instrument. It is important to note that Fibonacci retracement levels should not be used in isolation and should be used in conjunction with other technical analysis tools.
