Fibonacci Retracements Unravelling the Power in Stock Markets

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Marketopedia / Technical Analysis / Fibonacci Retracements Unravelling the Power in Stock Markets

Fibonacci retracements are quite fascinating. To comprehend the concept, one must know about the Fibonacci sequence. It is said to have its roots in ancient Indian mathematics from around 200 BC, yet it was an Italian mathematician Leonardo Pisano Bogollo -referred to as Fibonacci by his friends – who uncovered the numbers in the 12th century.

The Fibonacci sequence is a pattern of numbers that begins with zero, followed by the sum of the two preceding numbers.

The Fibonacci sequence is as follows:

0 , 1, 1, 2, 3, 5, 8, 13, 21, 34,  55, 89, 144, 233, 377, 610…

Take note of the following points. 

233 = 144 + 89

144 = 89 + 55

89 = 55 +34

It goes without saying that the Fibonacci series continues on, seemingly, forever. It has many intriguing qualities.

For any number in the series, divide it by the preceding one to find a ratio that is typically 1.618.

For example:

610/377 = 1.618

377/233 = 1.618

233/144 = 1.618

The Golden Ratio, also known by its Greek symbol Phi, is a ratio of 1.618, which can be found throughout nature. Its presence in the structure of the human face and flower petals, as well as animal bodies, fruits, vegetables and rock formations. 

For example:

89/144 = 0.618

144/233 = 0.618

377/610 = 0.618

Keep in mind that 0.618 corresponds to 61.8% when expressed as a percentage.

The same result is seen when dividing any Fibonacci number by the number two places higher in the sequence.

For example:

13/34 = 0.382

21/55 = 0.382

34/89 = 0.382

When 0.382 is expressed in terms of percentage, it is 38.2%

Additionally, when a Fibonacci number is divided by one that is three numbers higher in the sequence, it produces consistency.

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

It is thought that Fibonacci ratios, such as 61.8%, 38.2%, and 23.6%, have uses in stock charts. Fibonacci analysis can be used when there is a marked increase or decrease visible in prices. After a steep move either up or down, the stock usually attempts to correct before its next shift. For example, if the stock rises from Rs.50 to Rs.100, there may be a regression back to likely around Rs.70 prior to it reaching Rs.120.

The retracement level forecast is a useful tool for traders in order to identify the potential extent of a correction. Fibonacci ratios, such as 61.8%, 38.2% and 23.6%, can be used by traders so that they are ready to enter new positions in the direction of the trend.