Fibonacci Retracement

The Fibonacci Retracement is a trend line tool, used to identify support and resistance. It works best on all markets and time frames.

The fan is drawn by placing a trend line between two points (usually a trough and opposing peak). Five horizontal lines are drawn. The lines intersect the trend line between the two reference points at the Fibonacci levels of 0.0%, 8.2%, 50.0%, 61.8%, and 100.0%. Some of the lines might not be visible, because of the scale limitations in the chart window.

Thousands of years ago, mathematicians discovered that a certain number kept appearing throughout the natural world. It was the ratio describing how flower petals grew around their central stem, how a snail's shell swirled around its origin and how a galaxy extended from its core. More importantly for the financial community, this ratio described how consecutive numbers related to each other. This "golden ratio" of .618 was applied to numbers by the thirteenth century mathematician Leonardo Fibonacci.

The Fibonacci sequence starts like this: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, ..., where any number in the sequence is equal to the sum of the preceding two numbers. The ratio of any two consecutive numbers starts out by oscillating around .618 and approaches it exactly as the sequence continues.

So what does this have to do with trading? Actually, Fibonacci numbers are really one aspect of trading with Elliott Waves and Gann Angles but those are topics for other editions of "Tips." As we know, markets trend up and down, pause to retrace (consolidate, correct) then continue onward. These retracements often reclaim constant percentages of the original trend's move and can be predicted with good accuracy by the Fibonacci sequence.

The ratios of consecutive numbers at the start of the sequence are 1.00, .50 and .67. Market technicians have long known that market retracements tend to end at the 50% level as well as at one and two thirds. A retracement of 100% of the move provides a very strong support/resistance line. All of these are Fibonacci levels. The one and two thirds levels are really approximations of the Fibonacci ratio 61.8% and its inverse. As you can see, Fibonacci levels are simply refined versions of what traders have been using for years.

Reference: "Real World Technical Analysis", published by Commodity Research Bureau

Draw a Fibonacci Retracement

1. Right-click on the chart to display the context menu, and select Fibonacci Retracement.
2. Placing your cursor where you wish to start the trend line, left-click and drag over the chart, releasing your mouse where the trend line should end.

 

Show Prices for Fibonacci Retracement

Use this option to show the prices where each of the five retracement lines are placed.

1. Right-click on the tool to display the context menu.
2. Click Show Prices.