This method is based on the theory that specific patterns can be found in natural price movements. While there is no fool proof way to predict future stock prices, using the Fibonacci retracement as part of your trading strategy may help you spot potential buying and selling opportunities.
What is the Fibonacci retracement, and how is it used in stock trading strategies?
It is a technical analysis tool that can identify possible support and resistance levels for a stock or other asset. This method is based on the Fibonacci sequence, which mathematician Leonardo Fibonacci first described in the 13th century. According to this sequence, each number is the sum of the two numbers before it. For example, 0 + 1 = 1, 1 + 2 = 3, 3 + 5 = 8, and so on.
The basic premise behind using the Fibonacci retracement in trading strategies is that specific price patterns tend to occur as natural market movements. Based on these patterns, traders can use this tool to help them identify potential entry and exit points for their trades.
The most popular Fibonacci ratios used in trading are 23.6%, 38.2%, 50%, 61.8%, and 100%. Once these levels are determined, traders can look for price action that stalls or reverses around these levels as potential trade entry or exit signals.
While the Fibonacci retracement is just one of many technical analysis tools that traders can use, it can be a helpful way to identify possible support and resistance levels for stock prices. This tool is handy in conjunction with other technical indicators and chart patterns.
The history of Fibonacci retracement and its popularity among traders
Although Leonardo Fibonacci first described the Fibonacci sequence in the 13th century, it did not become widely used in trading until many centuries later. There are several reasons for its popularity, including:
It’s based on a sound mathematical principle – The principle underlying this method is sound, based on the natural growth patterns in many aspects of nature. It gives traders confidence to use a valid technique when using Fibonacci retracement levels to make decisions about their trades.
It can be easily applied to charts – Fibonacci retracement levels can be easily applied to price charts using software programs or drawing them manually. It makes it a relatively simple tool for traders to use.
It is widely used and accepted – Because Fibonacci retracement is such a popular tool, many traders are familiar with it and use it as part of their trading strategies. This increases its overall legitimacy in the eyes of the trading community.
How to use the Fibonacci retracement to identify potential support and resistance levels
Now that we have a basic understanding of the Fibonacci retracement and why it is used, let’s look at how to use this tool to help identify potential support and resistance levels for stock prices.
The first step is identifying the most recent high point and low point, and it can be done by looking for peaks and troughs in the price action or using technical indicators such as moving averages. Once these points have been identified, the next step is to divide the vertical distance between them by critical Fibonacci ratios.
As the most commonly used Fibonacci ratios are 23.6%, 38.2%, 50%, 61.8% and 100%, these levels are then plotted as horizontal lines on the price chart.
Once these levels are determined, traders can look for price action that stalls or reverses around these levels as potential trade entry or exit signals.
Tips for using the Fibonacci retracement in your trading strategies
If you are thinking about using the Fibonacci retracement as part of your trading strategies, there are a few things to keep in mind:
Use Fibonacci in conjunction with other technical indicators – While Fibonacci retracement can be a helpful tool, it is best used in conjunction with other technical indicators and chart patterns. It will help you confirm price action signals and make more informed trading decisions.
Be patient – Don’t expect Fibonacci retracement levels to provide perfect trade entry and exit points. Sometimes the market will move through these levels without reversing.
Don’t be afraid to experiment – Different stocks and market conditions may respond better to Fibonacci retracement levels, see this at Saxo Forex Broker. For example, in a strongly trending market, the 61.8% level may be more significant than in a range-bound market. As you become more familiar with this tool, don’t be afraid to tweak your trading strategies slightly to see what works best for your circumstances.