Fibonacci
The Fibonacci sequence is where the prior 2 numbers are added together to get the next number in the sequence: 1,2,3,5,8,13,21,34,55…… on up to infinity. If you take a number and divide by the next highest number in the sequence, the answer nears .618 (8/13 = .6153, 13/21 = .619……) as the numbers get higher. As a percentage .618 = 61.8% If you take a number and divide by the number that is 2 places higher in the sequence, the answer nears .382 (8/21 = .3809, 13/34 = .3823……) as the numbers get higher. As a percentage .382 = 38.2% If you take a number and divide by the number that is 3 places higher in the sequence, the answer nears .236 (8/34 = .2353, 13/55 = .2364……) as the numbers get higher. As a percentage .236 = 23.6%
These ratios are the basis of the Fibonacci Retracement tool that is used to identify potential support and resistance levels. These levels are potential reversal points for us to pay extra attention to for a return to the prior trend. There is one other retracement that the tool shows. The 50 % retracement is based off the Dow Theory that found major stock indexes often retrace half of their previous moves. The 23.6% retracement is considered a shallow retracement. In fact some tools do not show the 23.6 retracement level. The major retracements are considered to be at 38.2, 50, and 61.8.
The retracement tool is based on picking the beginning of a move and then the end of the move. The dashed redline shows the connection between starting and endpoints. The yellow lines show the different retracement levels. Notice how USDCHF pulled back initially 23.6% and finding temporary support before breaking down to a 38.2% retracement. It never did test the 38.2% level again. It went back through the 23.6 level to resume its upward trend. The other levels are where the pair could have retraced before resuming its upward trend. The retracements also work the same way in a downward trend, where a bounce could be expected to find resistance at the same percentage numbers. As always, there are no guarantees. However, if used with other resources, the Fibonacci Retracement tool can be a great asset.
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