The Fibonacci Retracements
The topic on Fibonacci retracements is quite intriguing. To fully understand and appreciate the concept of Fibonacci retracements, one must understand the Fibonacci series.
There are claims that the Fibonacci series dates back to 200 BC in the ancient Indian mathematical writings. However, Fibonacci numbers were first discovered in the 12th century by an Italian mathematician from Pisa by the name of Leonardo Pisano Bogollo.
The Fibonacci series is a set of numbers that begins at zero and is arranged so that any number in the series has a value equal to the sum of the two numbers before it.
The Fibonacci sequence is as follows:
0 , 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610…
Notice the following:
233 = 144 + 89
144 = 89 + 55 89 = 55 +34
Needless to say the series extends to infinity. There are few interesting properties of the Fibonacci series.
Divide any number in the series by the previous number; the ratio is always approximately 1.618.
For example:
610/377 = 1.618
377/233 = 1.618
233/144 = 1.618
The ratio of 1.618 is considered as the Golden Ratio, also referred to as the Phi.
Similarly, one can find remarkable consistency when a number in the Fibonacci series is divided by its immediate succeeding number.
For example:
89/144 = 0.618
144/233 = 0.618
377/610 = 0.618
At this stage, do bear in mind that 0.618, when expressed in percentage is 61.8%.
When any number in the Fibonacci sequence is divided by a number two places higher, a similar pattern emerges.
For example:
13/34 = 0.382
21/55 = 0.382
34/89 = 0.382
0.382 when expressed in percentage terms is 38.2%
Also, there is consistency when a number in the Fibonacci series is divided by a number 3 place higher.
For example:
13/55 = 0.236
21/89 = 0.236
34/144 = 0.236
55/233 = 0.236
0.236 when expressed in percentage terms is 23.6%.
Relevance to stocks markets
It is believed that the Fibonacci ratios, namely 61.8%, 38.2%, and 23.6%, can be applied to stock charts. The Fibonacci analysis can be utilized when there is a noticeable price increase or decrease. Whenever the stock moves sharply upwards or downwards, it has a tendency to retrace before making its next move. For instance, if a stock has risen from BDT 50 to BDT 100, it is likely to trace back to BDT 70 before it can reach BDT 120.
The 'retracement level forecast' is a method for predicting up to what level a pullback may occur. These retracement levels offer traders an excellent opportunity to enter new positions in the direction of the trend. The Fibonacci ratios, i.e. 61.8%, 38.2%, and 23.6%, assist the trader in determining the potential size and scope of the retracement. Using these levels, the trader can position himself for trade.
How should you use the Fibonacci retracement levels?
Think of a situation where you wanted to buy a particular stock but you have not been able to do so because of a sharp run up in the stock. In such a situation the most prudent action to take would be to wait for a retracement in the stock. Fibonacci retracement levels such as 61.8%, 38.2%, and 23.6% act as a potential level upto which a stock can correct.
By plotting the Fibonacci retracement levels, a trader can identify these retracement levels and thus position himself to take advantage of an entry opportunity. As with any indicator, the Fibonacci retracement should be used as a confirmation tool.
As mentioned previously, it is recommended to buy a stock if it has:
- Formed a recognizable candlestick pattern
- The stoploss coincides with the S&R level
- Volumes are above average
Along with the above points, if the stoploss also coincides with the Fibonacci level then the trade setup is well aligned to all the variables and hence you can make a purchase.
