A Little Information on Fibonacci Retracements:
How They Were Derived And How Traders Interpret Them
As the search for newer and better methods in analyzing market trends and forecasting future trading trends that can make young traders successful continues, a lot of new trading methods offering a lot of promises are also being introduced. A great number of these methods really do nothing or are just renamed versions of previous trading methods. However, some of these methods do really work. These are the tried and tested methods that have created a lot of successful traders. Among these tried and tested market trend analysis methods is Fibonacci trading, and the most popular tool under it is the Fibonacci retracements. Fibonacci retracements allow every trader to effectively forecast future turning points or reversals in the existing market trends, allowing them to make winning decisions in trading.
But what are retracements and how do they really work? In simple terms, a retracement is a pullback or a reversal in stock market trends from an existing major upward or downward market trend. In technical analyses, these future trend reversals are predicted through different retracement levels, as may be provided by the method used in technical analysis. In Fibonacci trading, different Fibonacci retracement levels are provided, with each Fibonacci retracement level predicting either a reversal or a continuation of the existing market trend. The various Fibonacci retracement levels are derived from the Fibonacci numbers and some of their significant ratios.
The Fibonacci numbers refer to the individual numbers in an infinite number sequence introduced by Leonardo Fibonacci, a great Italian mathematician of the middle ages. Fibonacci used the numbers as an answer to a problem regarding an idealized population growth of rabbits. Later, many mathematicians have discovered that the Fibonacci numbers has a lot of uses and that they actually exist in nature. In the field of marketing and trading, the Fibonacci numbers found use in various technical analysis methods, including Fibonacci retracements. Aside from Fibonacci retracements, the Fibonacci numbers are also used in various other technical analysis methods, including Fibonacci fans, Fibonacci arcs, Fibonacci spirals and time projection analyses. Collectively, these methods are known as Fibonacci trading.
But the Fibonacci numbers alone find no use in Fibonacci retracements. Instead, it is the various Fibonacci ratios that find use in deriving the various Fibonacci retracement levels. One of the most important ratios translates to the 0.618 Fibonacci retracement level, a ratio regarded by the ancient Greeks as the Golden Mean or the perfect proportion. This Fibonacci retracement level is derived by taking the ratio of two succeeding Fibonacci numbers.
Taking the ratio of two alternating Fibonacci numbers, on the other hand, leads us to another Fibonacci retracement level, the 0.382 Fibonacci retracement level. Other important Fibonacci retracement levels derived from the Fibonacci ratios are the levels 0.786, 1.272, and 1.618. Another Fibonacci retracement level is the level 0.5. While it was not derived directly from the Fibonacci numbers, it proves to be equally important, as it is the midpoint between the 0.618 and the 0.382 Fibonacci retracement levels.
Successful Fibonacci traders have found a lot of ways of interpreting the different Fibonacci retracement levels. But before any interpretation, the Fibonacci retracement levels are first plotted on a stock market trend analysis chart through horizontal Fibonacci lines. Some traders see the Fibonacci retracement levels as support and resistance levels. A trend approaching the 0.382 retracement level, for example, is indicative of a continuation in the major upward or downward trend, while the 0.618 retracement level is indicative of a major swing or trend pullback.
Some traders would interpret the various Fibonacci retracement levels in a different manner. They would often plot Fibonacci retracement levels in different time frames using a single chart. Overlapping Fibonacci retracement lines would indicate a stronger possibility of a major trend change.
Fibonacci retracements could not have been so popular was it not proven effective. While some traders say that the method simply does not work, a lot of traders have been very successful with the method. Their secret, probably, is the proper use and interpretation of the various Fibonacci retracement levels. Today's traders, however, will find interpreting the various Fibonacci retracement levels a lot easier as most Fibonacci trading software today allow them to interpret the various levels in more ways than one.