What Is a Fibonacci Retracement Level?
Developed by Leonardo Fibonacci in 1170 AD, Fibonacci ratios represent a set of key numbers (Fibonacci retracement levels) created by considering two extreme points of the ratios.
Horizontal lines represent Fibonacci retracement levels that represent support and resistance levels.
Each level corresponds to a specific ratio or percentage.
Fibonacci Retracement Level | Source: Investopedia
It illustrates how far the price has tried to reverse from a previous movement.
The prior trend is anticipated to continue in the same way.
Yet, before that occurs, the asset’s price normally returns to one of the above ratios.
How to Use Fibonnaci Retracement?
The Fibonacci sequence is a set of numbers that includes a certain pattern like 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
Every number in this sequence is the sum of its previous two numbers, and every number is 1.618 times greater than the previous number.
The Fibonacci ratios are calculated simply by dividing the numbers in the Fibonacci sequence.
Fibonacci ratios identify the price momentum of an asset in the financial markets.
Technical traders use them to draw support lines, visualize resistance levels, safeguard their capital by putting stop-losses at key Fib levels, and set take-profit targets.
How to Draw Fibonacci Retracement?
Most traders use Fibonacci retracements on a 1D chart to identify the long-term trend of an asset.
Another important thing Fibonacci retracements tell a trader is to include resistance levels, support lines, stop-loss targets, and entry levels.
What Is the Best Setting for Fibonacci Ratios?
Different traders use different ratios; however, the most common Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
Like every other technical indicator, Fibonacci retracements also have some flaws, and you should be aware of them before using this indicator to invest your capital in the financial markets.
The first disadvantage is that this indicator isn’t objective and works well only for some assets.
For Fibonacci retracement to work in the market’s favor, a significant amount of traders have to use the same Fib ratios, which will then reflect in the price momentum of the asset as well.