###
**What is a
Fibonacci Retracements?**

A Fibonacci retracements is a term used in technical analysis that
refers to areas of support or resistance. Use horizontal lines to show where support and resistance levels are feasible. Each level is
associated with a percentage. The percentage is how much of a prior move the
price has retraced. The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%
and 78.6%. While not officially a Fibonacci ratio, 50% is also used.

To fully
understand the concept of Fibonacci retracements, you must understand the
Fibonacci series.

The
Fibonacci series is a sequence of numbers starting from zero arranged in such a
way that the value of any number in the series is the sum of the previous two
numbers.

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

5 = 2+3 8 = 3 + 5

13 = 5 +8.

This 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

233/144 = 1.618

144/89 = 1.618

89/55 = 1.618

233/144 = 1.618

144/89 = 1.618

89/55 = 1.618

The ratio
of 1.618 is considered as the Golden Ratio, also referred to as the Phi.
Fibonacci numbers have their connection to nature.

Further
into the ratio properties, one can find remarkable consistency when a number is
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

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%.

Similar consistency can be
found when any number in the Fibonacci series is divided by a number two places
higher.

For example:

13/34 = 0.382

21/55 = 0.382

34/89 = 0.382

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

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 i.e 61.8%, 38.2%, and 23.6% finds its
application in stock charts. Fibonacci analysis can be applied when there is a
noticeable up-move or down-move in prices. Whenever the stock moves
either upwards or downwards sharply, it usually tends to retrace back before
its next move.

‘The
retracement level forecast’ is a technique using which one can identify upto
which level retracement can happen. These retracement levels provide a good
opportunity for the traders to enter new positions in the direction of the
trend. The Fibonacci ratios i.e 61.8%, 38.2%, and 23.6% helps the trader
to identify the possible extent of the retracement. The trader can use these
levels to position himself for trade.

Have a
look at the chart below:

I’ve
encircled two points on the chart, at Rs.380 where the stock started its rally
and at Rs.489, where the stock prices peaked.

I would
now define the move of 109 (380 – 489) as the Fibonacci upmove. As per
the Fibonacci retracement theory, after the upmove one can anticipate a
correction in the stock to last up to the Fibonacci ratios. For example, the
first level up to which the stock can correct could be 23.6%. If this stock
continues to correct further, the trader can watch out for the 38.2% and
61.8% levels.

Notice in
the example shown below, the stock has retraced up to 61.8%, which coincides
with 421.9, before it resumed the rally.

Here is
another example where the chart has rallied from Rs.288 to Rs.338. Therefore 50
points move makes up for the Fibonacci upmove. The stock retraced back 38.2% to
Rs.319 before resuming its up move.

The
Fibonacci retracements can also be applied to stocks that are falling, in order
to identify levels upto which the stock can bounce back. In the chart below the
stock started to decline from Rs.187 to Rs. 120.6 thus making 67 points as the
Fibonacci down move.

After the
down move, the stock attempted to bounce back retracing back to Rs.162, which
is the 61.8% Fibonacci retracement level.

Here is
another example where the chart has rallied from Rs.15 to Rs.31. Therefore 16 points
move makes up for the Fibonacci upmove. The stock retraced back 50% to Rs.23 before
resuming its up move.

###
**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 the trader can identify these
retracement levels, and therefore position himself for an opportunity to enter
the trade. However please note like any indicator, use the Fibonacci
retracement as a confirmation tool.

I would
buy a stock only after it has passed the other checklist items. In other words
my conviction to buy would be higher if the stock has:

1. Formed a
recognizable candlestick pattern

2. The
stoploss coincides with the S&R level

3. Volumes
are above average

Along
with the above points, if the stoploss also coincides with the Fibonacci level
then I know the trade setup is well aligned to all the variables and hence I
would go in for a strong buy. The usage of the word ‘strong’ just indicates the
level of conviction in the trade set up. The more confirming factors we use to
study the trend and reversal, more robust is the signal. The same logic can
also be applied for the short trade.

Fibonacci Retracements
Reviewed by Rajat Ajmera
on
16 March
Rating: