Fibonacci Retracements: How to use it in Technical Analysis?

By Trader Pit

July 8, 2021


Fibonacci retracements have been used for a long time to help predict the market, but they’re not really well understood by most traders. The idea behind them is fairly simple: the Fibonacci levels (0.618, 0.786, 1.618 etc.) are the support and resistance levels. If price is above the highest level, you can expect it to fall (in the short term at least). If price is below the lowest level, it is likely to rise (in the short term at least). The retracement levels are the same as the Fibonacci levels.

Fibonacci retracements have been widely used in technical analysis for more than a century, and they have long been considered to be powerful tools for determining support and resistance levels. But what exactly is a fibonacci retracement, and how do you use it to forecast future price action?

Understand what the Fibonacci retracement is and how to use it in trading: The Fibonacci concept was introduced by an Italian mathematician named Fibonacci (also known as Leonardo Bonacci or Leonardo of Pisa). This concept was introduced mainly to solve the problem of rabbit population growth. And now it has become one of the most interesting and popular concepts in mathematics and business.

In this article we will look at what a Fibonacci sequence is, what influence Fibonacci has on trading, and exactly how you can use Fibonacci in trading. Let’s get started.

What is a Fibonacci sequence?

Fibonacci is a sequence of numbers starting at zero and arranged so that the next number is the sum of the previous two.

So, the Fibonacci sequence looks like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377………

Below are the calculations you need to do to find the numbers in the Fibonacci sequence:

  • 0 + 1 = 1
  • 1 + 1 = 2
  • 1 + 2 = 3
  • 3 + 5 = 8
  • 5 + 8 = 13
  • 8 + 13 = 21
  • 13 + 21 = 34 and so on.

Some interesting facts about the Fibonacci sequence

Before we go any further, here are some interesting facts about the Fibonacci sequence that you should know:

  • If you divide any number by the previous number, the ratio is always 1.618 (233/144 or 144/89 or 89/55 or 55/34, etc.).
  • Second: If you divide the number by the next number, the ratio is always 0.618 (21/34 or 34/55 or 55/89, etc.).

Needless to say, the number 0.618 (or 61.8%) is important in the Fibonacci calculation.

  • If you divide a number in the range by the next higher two-digit number, the ratio is always 0.382 (21/55 or 34/89 or 55/ 144, etc.).
  • And if you divide any number in the sequence by the number three places higher, you still get the ratio 0.236 (21/89 or 34/144 or 55/233, etc.).

From the above facts, the Fibonacci percentage ranges are 61.8%, 38.2%, 23.6%.

The Fibonacci effect on trading

The 61.8%, 38.25% and 23.6% Fibonacci series are very dramatic on the graph of a company’s stock price. It is regularly used when we observe price movements. And it can be applied to all periods.

It is well known that the company’s share price does not move in one direction. Prices always zigzag. If a company’s stock price has gone from 100 to 150, it will probably fall before rising again. But to find the retracement level, the Fibonacci retracement levels are very useful.

For example, if the share price of a company before an increase = Rs. 100. In the first phase of the move, the share price rose to = Rs. 150

So if the share price falls by 38.2%, it will fall to = 150 – 38% of 50 = 131. And if the share price falls by 61%, it will fall to = 150 – 61% of 50 = 119 (approximately).

Fig. 1 : Maruti’s daily chart (www.zerodha.com)

Looking at the above figure, it seems that Maruti went from Rs. 4000 to Rs. 5500. And it looks like they can grow even more. But before moving up, the market is making a correction, ahead of the forecast range of 38.2% to 61.2%. And after consolidating in this area, it makes a new upward move and reaches a new current high.

So if someone is looking for a correction in the market, Fibonacci retracements are a very useful tool, and they also help to get into the market if someone misses the initial move.

Fig. 2 : Daily chart of BajajFinsv (www.zerodha.com)

If we look at the above figure 2, we can see that BajajFinsv’s share price has a downward trend. And it looks like it could go even lower.

Prior to the decline, however, the market made a small corrective rally and is now consolidating around the 38% retracement level. And now we see the stock price making lower highs and lower lows. As a result, we could see a return to bearish momentum and a breakout or retest of previous lows.

 

Short note
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Use of Fibonacci in trading

Suppose we want to buy shares of a certain company, but due to strong price dynamics, the price of the stock has increased significantly and it is very expensive to buy it at the current price. We expect a price correction here and assume the stock will fall back from the 61.8%, 38.2% or 23.6% levels.

In all cases, the following factors should also be considered before choosing the appropriate correction levels: Candlestick patterns near correction levels, price movement around the level, nearby support and resistance, volume at these correction levels, and the overall fundamental picture.

Supplement

In this article we have tried to explain what Fibonacci retracement is and how to use it in trading. Here are a few things from this article:

  • Fibonacci should be used when correction or projection levels need to be formed.
  • Second, Fibonacci is useful if you missed an entry into the first movement, but are still interested in buying shares of a particular company.
  • The important Fibonacci levels are 61.8%, 38.2% and 23.6%.
  • In other words, Fibonacci retracement levels should not be the only basis for entering a trade. In general, fundamental and technical factors should also be taken into account.

So much for that article. I hope this was helpful. If you have any questions about Fibonacci retracements, feel free to leave a comment below. I’d like to help you. Good business.

Hitesh Singhi is an active derivatives trader with over 10 years of experience in trading futures and options on Indian equities and international energy commodities like Brent, WTI, RBOB, gasoline etc. He has traded on BSE, NSE, ICE and NYMEX. Hitesh’s credits include a degree in business management and an MBA in finance. Follow Hitesh here on Twitter!

Frequently Asked Questions

How do you analyze Fibonacci retracement?

The Fibonacci retracement is a technical analysis tool that is used to determine the support and resistance levels of a given price movement. The Fibonacci retracement is calculated by taking the difference between the high and low of the given price movement and dividing it by the Fibonacci number that is one less than the number of the given price movement.

How do you use Fibonacci retracements?

The Fibonacci retracement is a tool that is used to determine the level of support or resistance a stock may find at a certain price. The Fibonacci retracement is a mathematical tool, which is used to calculate the retracement levels of a stock. The Fibonacci retracement is calculated by dividing the difference of the high and low prices by the number of days in the time frame. The first number is the number of days that have passed since the high price, and the second number is the number of days that have passed since the low price.

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About the author

Trader Pit

A yogi who like Finance and Technology. I have been in Indian Stock market for over 12 years now as financial analyst, portfolio manager, trader. Now, I focus on Yoga, Financial Education & Long term investing. 

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