Lesson 6: An Introduction to Technical Analysis

Fibonacci Retracement

Overview

  • Leonardo Fibonacci was a 13th century mathematician who noted that the natural world seemed to consistently repeat patterns based on the same set of numbers.
  • Technical analysts have adapted the Fibonacci Sequence as one means to predict future rate levels immediately after a major price fluctuation.
  • The theory is that after a rate spike in either direction, the rate will often return – or retrace – part way back to the previous price level before resuming in the original direction.
  • Some analysts believe that these retracement levels often match ratios derived from numbers in the Fibonacci Sequence.
  • The most commonly-used ratios include the following:
    1. 61.8% – also known as the "golden mean", it is considered the most reliable of the Fibonacci Ratios and is derived by dividing any number in the sequence by the number that immediately follows. The average result is 61.8%.

    2. 38.2% – found by dividing any number in the sequence by the number two places to the right. The average result is 38.2%.

    3. 23.6% – found by dividing any number in the sequence by the number three places to the right. The average result is 23.6%.

  • In addition to these ratios, most trading platforms also show retracement lines at 50 and 100 percent. You can see the Fibonacci retracement ratio lines placed over the following price chart:
fibonacci retracement graph
Standard Fibonacci Retracement Lines
  • To understand how Fibonacci Ratios are used, consider an exchange rate that is trending upwards. After a particularly large increase, the price often retraces, giving up part of the gain before continuing upwards again.
  • The same principle applies for a price that is trending downwards - you should expect some retracement upwards after a large price drop.
  • Retracements are the levels that traders look for when determining new support and resistance levels for their trading strategy, and these levels often align with the Fibonacci ratios.
  • It is only prudent, of course, that you do not act solely on Fibonacci levels to make decisions. As with any indicator, you should confirm your results with another form of analysis to support your rate direction decision.

The Fibonacci sequence is created by adding one number in the sequence to its previous number to arrive at the next Fibonacci number. For example:

0 + 0 = 0
0 + 1 = 1
1 + 0 = 1
1 + 1 = 2
2 + 1 = 3
3 + 2 = 5
5 + 3 = 8

 

Following this pattern, the first 25 numbers in the Fibonacci Sequence are 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10,951, 17,716, 28,667, 46,383

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