Fibonacci retracement is a tool which is available to every technical analyst. The original numerical sequence was identified by the Italian mathematician Leonardo Fibonacci in the early 13th century. It goes as follows – 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, etc. As you might have noticed, each number is the sum of two previous numbers.
With further inspection you might also notice that each number is around 1.618 times greater than the previous one. For example, 89/55 = 1.618. This relationship is often referred to as the “Golden Ratio”, and it has led to many scientists and artists have studying it, searching for its universal meaning. Leonardo Da Vinci famously started using the rules of the Golden Ratio in his paintings.
When we talk about the Fibonacci sequence in terms of financial trading, we find that a lot of attention is devoted to them. In particular, traders pay attention to areas when prices are close to certain levels. The 61.8%, 38.2%, and 23.6% retracement levels are derived from the Fibonacci sequence. 61.8% is one number divided by the next number in the sequence, i.e. 34/55. 38.2% is derived from a number divided by the one two steps away, so 34/89. Finally, 23.6% is derived when dividing a number by the one three steps away, i.e. 34/144.
When we look at charts and see a certain range, we can track these levels and observe how prices behave through order flow. In addition to Fibonacci ratios, traders also pay attention to the 50% and 78.6% levels. Traders watch out for reversals and breakthroughs at all of these levels, so trading using Fibonacci almost becomes a self-fulfilling prophecy.
As usual, we prefer to wait for the confirmation before we consider an entry.