Understanding and Using Fibonacci Retracements in Stock Trading

If you are considering the use of Fibonacci retracements in your stock trading ventures but you are not sure where to start, then you have come to the right place. In order for you to benefit from using this method of plotting, it is very important that you know exactly how to use it before taking the plunge.

What Are Fibonacci Retracements?

In financial terms, Fibonacci retracements is a well-known method of technical analysis that is used to determine the areas of support and resistance levels within a trend’s range. This is primarily based on the idea that any given financial asset’s move in price range will potentially retrace or correct before continuing its initial, original trending path. The retracement itself is created by two extreme charting points in which the vertical distance thereof is divided by the key Fibonacci ratios. Generally speaking, 0% would be the actual start of a retracement, while 100% will be a reversal to the original move.

The Math

This indicator uses mathematical ratios that are based on the relationship between set sequences of numbers known as the Fibonacci sequence. Here, two consecutive numbers are added in order to get the next number.

Sequencing Example:

1, 1, 2, 3, 5, 8, 13, 21 (1 + 1 = 2 | 1 + 2 = 3 | 2 + 3 = 5)

The relationship between theses number will ultimately create the oh-so familiar retracement levels and ratios that you will come to know in charting stocks.

Example of Popular Ratios:

0.236 (23.6%)
0.382 (38.2%)
0.500 (50%)
0.618 (61.8)
0.764 (76.4%)

Using Fibonacci Retracement in Stock Trading

Fibonacci retracement works in the same way as any other technical indicator out there. Now, the first thing you should know about this tool is that it works better when the market is trending. The ultimate idea here is to buy on retracement at support level when the market trends upwards, and to sell on retracement at a resistance level when the market trends downward. However, in order to successfully find and manage these retracement levels, you should first find the swing lows and highs.

To ensure simplicity and effectiveness when using Fibonacci retracement for the first time, do so in the sense of general support and resistance targeting. Remember, the results are potential market turns and not guaranteed turns. While this indicator is said to be one of the best available to you, you will be happy to know that there are also several other indicators that you can use in addition to the Fibonacci retracement – ultimately enhancing your chances of success.