The Fibonacci retracement levels are a useful tool for investors to confirm entry points in the direction of the trend. These levels help identify reversal areas where a reversal can change the direction. These levels consist of four numbers: 76.4, 61.8, 38.2, and 23.6. However, Fibonacci levels will not always pinpoint market turning points accurately.
Origins of Fibonacci Levels
The origins of Fibonacci levels trace back to a sequence of numbers introduced by the Italian mathematician Leonardo Fibonacci in the 13th century. The sequence begins like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 … each new number is the sum of the two preceding ones. As the series progresses, each number is approximately 61.8% of the next number, approximately 38.2% of the next number, and approximately 23.6% of the number after that. Subtract 23.6 from 100, and the result is 76.4. These four numbers constitute the Fibonacci retracement levels: 76.4, 61.8, 38.2, and 23.6.
Importance of the Sequence
Fibonacci and the scientists before him discovered that this sequence is prevalent in nature in spiral forms like shells, flowers, and even galaxies. As the spiral grows outward, it does so at the same rate as the proportions derived from Fibonacci ratios. Some believe that these ratios extend beyond shapes in nature and actually predict human behavior. The thinking goes, fundamentally, that people begin to feel uncomfortable with trends that cause changes too rapidly and adjust their behavior to slow or reverse it.
Fibonacci Retracement Levels in the Stock Market
When a stock has a very strong trend in one direction, it is believed that a reversal will occur at one of the levels included in the Fibonacci retracement levels: 23.6%, 38.2%, 61.8%, or 76.4%. Some models also include 50%. For example, if a stock price rises from $10 to $11, it is likely that the reversal will be around 23 cents, 38 cents, 50 cents, 62 cents, or 76 cents (the mentioned percentages apply to the dollar). It is known that early or late in trends, when the price is still gaining or losing momentum, it is common to see reversals at higher percentages.
How to Use Fibonacci Retracement Levels
If your trading strategy provides a short-sell signal in that price area, the Fibonacci level helps confirm the signal. Fibonacci levels also indicate price areas where you should be on high alert for trading opportunities. In the example scenario above, for instance, if you see that the stock declines by 38 cents from $11 to $10.62, you might notice that this is a Fibonacci number. This could be a good buying opportunity, knowing that the stock will likely bounce back up.
Reversal Warnings
Despite the usefulness of Fibonacci levels, they will not pinpoint market turning points accurately. They provide an estimated entry area rather than an exact entry point. There is no guarantee that the price will stop and reverse at a specific Fibonacci level or at any of them. If the price retraces 100% of the last price wave, it may indicate a trend failure. Furthermore, if you use the Fibonacci retracement tool on very small price movements, it may not provide much familiarity. The levels will be too close to each other, making it seem that almost every price level is significant. Fibonacci levels provide some areas of interest for reversals. They can be confirmed if you receive a trading signal in a Fibonacci level area. Experiment with Fibonacci retracement levels, apply them to your charts, and use them if you find they help in trading.
Questions
Frequently Asked Questions (FAQs)
How to calculate Fibonacci retracement levels?
Fibonacci levels are simple ratios. To calculate a Fibonacci level, you first need to measure the size of the previous move. The ratios are based on that move. If a stock rose from $230 to $240, for example, the levels would be based on a $10 move. To calculate the 76.4% Fibonacci level, multiply the $10 by 76.4% (10 × 0.764 = 7.64) and subtract that number from $240 to get your 76.4% level ($240 – 7.64 = $232.36).
How to add Fibonacci retracement levels to TradingView?
Most trading and charting software will allow you to add Fibonacci retracement levels, but they may place the tool in slightly different locations. Generally, this tool can be found next to other drawing tools that allow you to mark up your chart. If you are using TradingView, you can also use the keyboard shortcut alt + f (option + f on Mac).
Source: https://www.thebalancemoney.com/how-to-use-fibonacci-retracement-levels-when-day-trading-1031211
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