Theory of Fibonacci: What is Fibonacci Retracement?

Fibonacci is a number game, which as a trader you must track to find the movement of the stock. 

You may observe that sometimes in the stock market, when a stock moves either downward or upward with sharp force, it tends to show retracement before its next move.

Using the Fibonacci sequence, traders find the Fibonacci levels that help in planning to trade on charts. 

Let’s not wait anymore and start this blog so that you receive the potential to analyse the financial markets accurately. 

1. Fibonacci Theory 

Fibonacci for trading is a popular form of technical analysis used by stock market traders to predict the potential prices of a security or an asset in financial markets. 

There are Fibonacci ratios and retracements developed to identify the sharp support and resistance levels through the previous price action. 

Always remember that Fibonacci is known as a confirmation tool that should be used with other tools such as trend lines, moving average convergence divergence, volume and moving averages. 

When using Fibonacci, the greater the number of indicators used in the chart, the higher will be the chance of accurate trade plotting. Therefore, use indicators to confirm your trend with the Fibonacci indicator. 

2. History of Fibonacci 

As a technical trader your work will be 90% technical with the analysis and trading in stock markets. However, the theory is what consists in developing your base for the stock markets. 

Thus, before we get into too much detail, let’s understand the history of Fibonacci.              

Leonardo Pisano also known as Leonardo Fibonacci was a European mathematician who write the book of calculation in 1202 A.D. This is a book that included a variety of topics on how to measure commerce, run the economy, convert currencies, profits & interest calculation and more. 

In his book, he described the Arabic numeral system which was more powerful than the roman numerals used at that time. The entire community received hold of the Arabic numeral system and eventually, it was in the application which is continued to the present day. This was the first and most important development by Leonardo. 

The second important development given in the book was the Fibonacci Sequence which derived its use in stock markets with time. Let’s understand the development of sequence.  


3. Fibonacci Sequence 

Fibonacci sequence meaning that it is a series of numbers or set of integers that start with 0, 1 and then another one, in this manner by steadily increasing numbers. 

For example, 

The series starts with 0 and 1, and then the next number is (0+1) followed by (1+1) and so on. 

Here is what the sequence would look like: 

0,1,2,3,5,8,13,21,34,55,89,144 and so on…

A single sequence might be confusing for you when you enter it, however, if you enter the formula we mentioned before, it will be easier for you to spot. 

1=1=2; 1+2 = 3; 2+3 =5; 3+5=8; and so on…

The Fibonacci sequence is important for traders to know as it calculated the Fibonacci Ratios which are calculated through the sequence. 

In short, Fibonacci numbers in a sequence is a steadily increasing number where each number is termed equal to the sum of the previous two numbers. Now, let us learn about ratios to keep up with the theoretical understanding of Fibonacci. 

4. Fibonacci Ratios 

Fibonacci Ratios are derived from the Fibonacci sequence through a series of percentages calculated by dividing the sequence figures. The most used Fibonacci ratios which are used in the retracement settings are: 

    23.6%, 38.2%,61.8%, 78.6% and 161.8%

There are many Fibonacci ratios and levels used in to detect the market level, although the above setting is the most used and is derived from the Fibonacci numbers. 

Let’s hop in to understand an example to find the math behind the 61.8% Ratio. 

First, remember the Fibonacci sequence that we mentioned above? You must divide each number in the sequence by the one that follows it, to receive the mentioned ratio as roughly 0.0618. 

0 ÷ 1 = 0
1 ÷ 1 = 1
1 ÷ 2 = 0.5
2 ÷ 3 = 0.67
3 ÷ 5 = 0.6
5 ÷ 8 = 0.625
8 ÷ 13 = 0.615
13 ÷ 21 = 0.619
21 ÷ 34 = 0.618
34 ÷ 55 = 0.618
55 ÷ 89 = 0.618

When you receive 0.618, you can convert it into a percentage as 61.8%. 

On the other hand, if you divide each number by the one that precedes it, you will get 161.8%. 

4.1 Fibonacci Golden Ratio 

The most important ratios retrieved from Fibonacci levels are 61.8% and 161.8% which are also known as fibonacci golden ratio. These are the ratios that are used frequently in calculation of maths, stock markets, geometry and more. 

4.2 Gann Ratio 

Gann Ratio is another common ratio which is commonly used during Fibonacci analysis which is 50%, however, it is not derived from the Fibonacci sequence. Unlike, other ratios it is independent of its own to perform with relevancy during trading. It is often included in Fibonacci Technical analysis because it is important for deriving predictions. 

5. Fibonacci Retracement 

Fibonacci Retracement is analysed as a finding level of a stock to which the stock might come back to the movement and be ready for momentum trading. 

In easy words, when a market has risen, and is trading in uptrends when soon it starts falling back. Now, traders use Fibonacci ratios to find the retracement levels to figure out where the fall may take a pause and it resumes to the previous rise. 

Fibonacci retracement levels are accurately marked to find out the reversal points on both sides which makes it important for traders to learn. The retracement levels are used to predict the support and resistance in stock market when it retraces. 

For instance, Bank Nifty tumbles 500 points which is a part of a bearish trend in the stock market. Now, you as a trader expect a countertrend to enter in the index as buyer while justifying its fall in the market. 

According to Fibonacci Theory, a countertrend can be found through the observation of support and resistance levels using Fibonacci Ratios of the movement which is often taken as 23.6%, 38.2%, 61.8% and 78.6%. You can use retracement drawing tool to add the Fibonacci ratios on the charts. 

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You can add your retracement levels and ratios to plot where the reversal may arise in the next move of the index or stock. Fibonacci retracement is used as a drawing tool to find retracements in security, index, currencies, or other assets by plotting accurate support and resistance levels. 

The Bottom Line

Honestly, the term Fibonacci is foreign to many new traders and not everyone is a fan of Fibonacci approach during technical analysis. Therefore, our theoretical understanding to Fibonacci has introduced you to the basic set of information that a new trader should know. Fibonacci sequence is a set of numbers which develops Fibonacci ratios to help traders plot them in the security’s graph to find Fibonacci retracements. There are many technical indicators in trading, however using indicators that compliment each other during technical analysis is what helps a trader to sustain in the market. Hence, use trendlines, MACD and more indicators with Fibonacci retracement levels to find the accurate potential movement in the trade.  

Key Takeaways

  • Fibonacci is a confirmation tool/indicator

  • Fibonacci demands for greater number of indicators while analysis to get the accurate prediction. 

  • Fibonacci was analysed from the book by Leonardo Pisano also known as Leonardo Fibonacci

  • Fibonacci sequence was developed from the historical book

  • Most common Fibonacci sequence is 0,1,2,3,5,8,13,21,34,55,89,144 and so on.

  • Most common Fibonacci Ratios are 23.6%, 38.2%,61.8%, 78.6% and 161.8%

  • 61.8% and 161.8% are known as Golden Ratios derived from Fibonacci Numbers. 

  • 50% is known as a Gann Ratio which is not derived from Fibonacci Numbers

  • Fibonacci retracement is used to find the reversal points in the chart using the Fibonacci ratios through support and resistance levels. 


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