Fibonacci Retracements

The subject of Fibonacci retracements is really interesting. To completely comprehend and appreciate the notion of Fibonacci retracements, it is necessary to first comprehend the Fibonacci series. The Fibonacci series’ origins can be traced back to ancient Indian mathematical texts, with some claims reaching back to 200 BC. However, Fibonacci numbers were discovered in the 12th century by Leonardo Pisano Bogollo, an Italian mathematician from Pisa known to his friends as Fibonacci.

The Fibonacci series is a sequence of numbers beginning with zero and structured in such a way that the value of every number in the series is the sum of the two numbers before it.

The Fibonacci sequence looks like this:

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 goes on indefinitely. The Fibonacci sequence has a few intriguing characteristics.

Divide every number in the series by the previous number; the resulting ratio is consistently around 1.618.

For example:
610/377 = 1.618
377/233 = 1.618
233/144 = 1.618

The Golden Ratio, often known as the Phi, is defined as a ratio of 1.618. Fibonacci numbers have a natural link. The ratio can be found in human faces, flower petals, animal bodies, fruits and vegetables, rock formations, and galaxy formations, among other things. Of course, we shouldn’t go into this debate because it would take us away from the essential point. For those who are interested, I recommend searching the internet for golden ratio instances; you will be pleasantly pleased. Further investigation into the ratio qualities reveals remarkable consistency when a number in the Fibonacci series is split by its immediately subsequent number.

For example:
89/144 = 0.618
144/233 = 0.618
377/610 = 0.618

At this point, keep in mind that 0.618 is 61.8 percent when presented as a percentage.

When any number in the Fibonacci series is divided by a number two places higher, there is a similar consistency.

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, consistency is 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

The Fibonacci ratios, which are 61.8 percent, 38.2 percent, and 23.6 percent, are thought to be used in stock charts. When there is a noteworthy up-move or down-move in pricing, Fibonacci analysis can be used. Whenever the stock makes a sharp upward or downward move, it tends to retrace back before making the following move. For example, if a stock has risen from Rs.50 to Rs.100, it is likely to retrace to Rs.70 before rising to Rs.120.

The retracement level forecast’ is a strategy that can predict how far a pullback can go. These retracement levels offer traders an excellent opportunity to start new positions in the trend direction. The Fibonacci ratios, 61.8 percent, 38.2 percent, and 23.6 percent, assist the trader in determining the potential amount of the retracement. These levels can be used by the trader to position himself for a trade.

Have a look at the chart below:

I’ve circled two places on the chart: Rs.380, where the stock began its run, and Rs.489, where it peaked.

The Fibonacci upmove would now be defined as 109 (380 – 489). According to the Fibonacci retracement hypothesis, after the upmove, one should expect the stock to correct up to the Fibonacci ratios. For example, the stock’s initial corrective level may be 23.6 percent. If this stock continues to fall, traders should keep an eye on the 38.2 percent and 61.8 percent levels.

In the example below, the stock retraced up to 61.8 percent, which corresponds to 421.9, before resuming its advance.

We can arrive at 421 by using simple math as well –

Total Fibonacci up move = 109

61.8% of Fibonacci up move = 61.8% * 109 = 67.36

Retracement @ 61.8% = 489- 67.36 = 421.6

Similarly, we may compute 38.2 percent and various ratios. However, this does not have to be done manually because the software will do it for us.

Here’s another example of a chart that has risen from Rs.288 to Rs.338. As a result, a 50-point move compensates for the Fibonacci upmove. The stock fell 38.2 percent to Rs.319 before resuming its upward trend.

The Fibonacci retracements can also be used to identify levels above which a declining stock can recover. In the chart below (DLF Limited), the stock began to fall from Rs.187 to Rs.120.6, creating a Fibonacci down move of 67 points.

Following the downtrend, the stock attempted to retrace back to Rs.162, which is the 61.8 percent Fibonacci retracement level.

Fibonacci Retracement construction

Fibonacci retracements, as we now know, are chart moves that go against the trend. To apply Fibonacci retracements, we must first determine the 100 percent Fibonacci move. The 100 percent move might be either upward or downward. To determine the 100 percent move, select the most recent peak and trough on the chart. Once this is determined, we use a Fibonacci retracement tool to connect them. This feature is present in the majority of technical analysis software packages, including Zerodha’s Pi.

Here is a step-by-step guide:

Step 1) Identify the immediate peak and trough. In this case, the trough is at 150, and the peak is at 240. The 90-point moves make it 100%.

Step 2) Select the Fibonacci retracement tool from the chart tools

Step 3) Use the Fibonacci retracement tool to connect the trough and the peak.

After selecting the Fibonacci retracement tool from the charts tool, the trader must first click on the trough and then drag the line to the peak without un-clicking. At the same time, the Fibonacci retracement levels begin to be drawn on the chart. However, the software only completes the retracement identification procedure when both the trough and the peak have been selected. After picking both points, the chart looks like this.

The Fibonacci retracement levels have now been calculated and loaded onto the chart. Use this information to determine your market position.

How should you use the Fibonacci retracement levels?

Consider a case in which you wanted to buy a specific stock but were unable to do so due to a significant increase in the stock’s price. In such a case, the most logical course of action would be to wait for a pullback in the stock. Fibonacci retracement levels such as 61.8 percent, 38.2 percent, and 23.6 percent serve as potential levels for stock to correct to.

The trader can detect these retracement levels and position himself for an entry opportunity by plotting the Fibonacci retracement levels. However, as with any signal, the Fibonacci retracement should be used as a confirmation tool.

I would only buy a stock if it met the other criteria on the checklist. In other words, my willingness to buy would be stronger if the stock:

1. Formed a recognizable candlestick pattern

2. The stoploss coincides with the S&R level.

3. Volumes are above average.

Along with the previously mentioned parameters, if the stoploss also coincides with the Fibonacci level, I know the trade setup is properly aligned to all variables, and thus I would go in for a powerful buy. The term “strong” refers to the level of conviction in the trade setup. The stronger the signal, the more confirming factors we utilise to evaluate the trend and reversal. The same approach can be applied to short trades.

Conclusion

1. Fibonacci retracement is based on the Fibonacci series.

2. A Fibonacci series possesses numerous mathematical features. These mathematical features can be found in many different elements of nature.

3. Traders believe the Fibonacci series can be used to identify probable retracement levels in stock charts.

4. Fibonacci retracements are levels (61.8 percent, 38.2 percent, and 23.6% ) to which a stock can retrace before resuming its initial directional trend.

5. The trader can consider opening a new trade at the Fibonacci retracement level. However, before proceeding with the trade, other elements on the checklist should be confirmed.