what is the use of fibonacci retracement?
nahasauthorThe Usefulness of Fibonacci Retracement in Trading
The Fibonacci retracement is a popular technical analysis tool used by traders and investors to identify potential price reversals and entry points. It is based on the Fibonacci sequence, a mathematical concept developed by the Italian mathematician Leonardo Fibonacci in the 1200s. The Fibonacci retracement helps traders understand how prices tend to re-establish previous high or low points, which can be valuable information for making trading decisions. In this article, we will explore the usefulness of the Fibonacci retracement in trading and how it can be applied to various investment strategies.
The Fibonacci Sequence and Retracement
The Fibonacci sequence is a series of numbers where each number is the sum of the two previous ones. The sequence starts with 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and so on. Fibonacci numbers have been observed in various natural patterns, such as the growth of plants and animals, and the relationship between their parts. In trading, the Fibonacci sequence is used to identify potential price patterns and re-establishment points, which can help traders make informed decisions about entry and exit points.
The Fibonacci retracement is a way to measure how prices tend to re-establish previous high or low points. It is calculated by dividing the distance between two prices by the sum of their Fibonacci numbers. For example, if prices move from $100 to $150 and then retrace back to $120, the 61.8% retracement would be $126.50, which is $6.50 higher than the original low of $120.
The Usefulness of Fibonacci Retracement in Trading
1. Identifying Potential Reversal Points: One of the most common uses of the Fibonacci retracement is to identify potential price reversals. Traders can use the 61.8% and 100% retracement levels as potential entry and exit points for trades. If prices break below the 61.8% retracement, it may indicate that the current trend is over, and traders should consider closing their positions. Conversely, if prices break above the 100% retracement, it may indicate that the current trend is renewed, and traders should consider adding to their positions.
2. Timing Exit Points: Fibonacci retracement can also be used to time exits on trades. Traders can use the 61.8% retracement as an exit point if prices break below this level, indicating that the current trend is over. Similarly, the 100% retracement can be used as an exit point if prices break above this level, indicating that the original trend has been restored.
3. Position Management: Fibonacci retracement can also be used for position management purposes. For example, if a trader buys at the 61.8% retracement and the price moves higher, they may consider selling a portion of their position at the 78.6% retracement to lock in some profits. Similarly, if the price moves lower, they may consider selling a portion of their position at the 23.6% retracement to protect their losses.
4. Market Timing: Fibonacci retracement can also be used for market timing purposes. Traders can use the 61.8% retracement as a potential entry point for a new market cycle, while the 100% retracement can be used as a potential exit point for the old cycle. By doing so, traders can try to capture the most profitable parts of a market cycle and minimize the unprofitable parts.
The Fibonacci retracement is a powerful technical analysis tool that can help traders and investors make informed decisions about potential price reversals, entry points, and position management. By understanding the Fibonacci sequence and retracement and applying it to their trading strategies, traders can gain a better understanding of market patterns and make more informed decisions about when to enter and exit trades. However, it is important to remember that technical analysis should always be used in conjunction with fundamental analysis and a sound trading strategy, as well as considered along with other risk management factors.