What is Fibonacci Retracement?

Want to know about Fibonacci Retracement? Fibonacci retracement in finance is a technical analysis approach to determine the support and resistance levels.

But before that, you need to first understand about Fibonacci numbers. These Fibonacci numbers come in a very natural sequence and also act as a base for a Fibonacci retracement.

As they can found in petals of flowers, So the majority of flowers if you count have 3, 5, or 8 petals. Even the cones in pineapple, the breeding cycle of rabbits also follows the Fibonacci sequence. There is just a never-ending list.

➤ Solve the following Equations

Would you do us a favor by dividing the following:

a. 13/21
b. 34/55
c. 89/144

If you have done the calculation on your calculator you will be surprised to find out the answer for all of them is 0.61. So few questions that we cross by after these calculations are:

1. What kind of trick is that?
2. How do the answers come the same?
3. What is the use of Fibonacci numbers or sequence?

Don’t worry you will get all the answers to your questions. So let’s begin.

What are Fibonacci Numbers?

Fibonacci numbers are natural numbers i.e., 0,1. These are basically two numbers. Now with the help of these two, we will try to understand the Fibonacci Sequence by using the basic two numbers 0,1.

Let’s write the sequence here by beginning with Fibonacci basis numbers:

0,1

Step 1: 0+1 =1
This answer goes to the sequence so our new sequence would be
0,1,1

Step 2: Now try to add the numbers in the sequence again to get the next number. That would be
1+1 = 2
Sequence would be then 0,1,1,2

Step 3: Add last two numbers 2+1 = 3
New Sequence would be 0,1,1,2,3

If we keep adding,
3+2= 5
5+3= 8
8+5= 13
13+8=21
21+13=34
34+21=55
55+34=89
89+55=144
and so on and so forth

So our sequence would be 0,1,1,2,3,5,8,13,21………

All you have to do is add the current number with the previous number. So by now, we know how the Fibonacci numbers can make a sequence.

Fibonacci Omniverse

Now because of the Fibonacci pattern can be found in nature itself. Many people starting wandering what if they can apply the same in trading.

The same logic then applied to stock markets to find out the retracement levels or Golden Ratio.

Now to under the Golden ratio let’s use the Fibonacci Sequence again and instead of adding we are going to divide one number with another number.

Choose any number from the Fibonacci Sequence.
0,1,1,2,3,5,8,13,21,34,55,89….

For instance, we are choosing 89.

Now divide the chosen no with the same no. Then divide the chosen number immediately previous to that number. Then skip a number in between and divide the chosen number. Then skip 2 numbers in between and divide it with the chosen number. So, calculations would seem like this:

89/89 =1
55/89 =0.61
34/89 =0.38
21/89 =0.23

You can follow this practice by dividing it with any of the Fibonacci numbers.

That was the reason for getting 0.61 as an answer for all the above calculations. This is also known as the Golden Ratio.

So all we are left with Fibonacci Retracement. For that let’s focus on retracement first.

Retracement means if there is a specific direction then suddenly going against that specific direction is Retracement. In other words a turning point in a moment of action.

Types of Retracements

Retracement can be of two types Up-trending retracement and Down-trending retracement.

1. Up-Trending Retracements = If the market in an uptrend and started going down. It means retracement of the downside.
2. Down-Trending Retracements = If the market is in the downtrend and then starts going up. It is the retracement of the upside.

So, when we merge this concept, it determines the support and resistance levels in trading. Apart from this, there’s another thing to keep in mind while trading.