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Fibonacci Retracement Levels
FOREX traders try to predict the direction of movement of currency pair trades so that they can profit from the moves. One method of technical analysis that FOREX traders have found useful for that purpose is Fibonacci Analysis.
FOREX traders use Fibonacci retracement levels to help predict support and resistance levels for currency pair market moves, to increase their profits.
The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms and sequence continues infinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies. This number sequence is named after Leonardo Fibonacci (~ 1175 AD to ~ 1250 AD), an Italian mathematician who discovered it. Fibonacci ratios seem to have mystical qualities, closely related to many natural phenomenon.
Fibonacci retracement levels are calculated by taking two extreme points (usually a major peak and trough) on a price chart and dividing the vertical distance by the key Fibonacci ratios. Fibonacci ratios can be plotted on a graph which displays price over time. Key Fibonacci ratios are 23.6%, 38.2%, 61.8%, and 78.6%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels as the price falls back.
The key Fibonacci ratio of 61.8% - also referred to as "the golden ratio" or "the golden mean" - is found by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.
The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 55/144 = 0.3819.
The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example: 8/34 = 0.2352.
For reasons that are unclear, these ratios seem to play an important role in the financial markets, just as they do in nature, and can be used to determine critical points that cause an asset's price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above. Thus the Fibonacci retracement levels are levels of support and resistance that traders can use to predict price movements and turnarounds, to increase their profits.
When methods like this are used, they can often become a self-fulfilling prophecy as more and more traders jump on the bandwagon.
In addition to the ratios described above, many traders also like using the 50% and 78.6% levels. The 50% retracement level is not really a Fibonacci ratio, but it is used because of the overwhelming tendency for an asset to continue in a certain direction once it completes a 50% retracement.
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