# Fibonacci Retracements – A Profitable Trading Strategy

The concept of Fibonacci Retracements comes from the concept of the Fibonacci Sequence. Leonardo Pisano, called Fibonacci, was an Italian mathematician who introduced the Fibonacci Sequence in his book Liber Abaci (Book of Abacus). In a Fibonacci Sequence, the first two numbers are 0 and 1. Each term in the sequence after 0 and 1 is a sum of the preceding two numbers. Thus, the Fibonacci sequence formed look like – 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 and so on.

#### Now the question is, how do you use this sequence to profit while taking positions in the stock market?

Before jumping to the strategies, let us understand the unique characteristics of this sequence. If you observe carefully, each term in the sequence is approximately 1.618 times larger than the preceding number. The number 1.618 is called Phi or the Golden Ratio. This ratio has mysteriously found traces in architecture, the natural world, fine art, and biology. In trading, the inverse of this Phi or the Golden Ratio – 0.618 – is used.

While trading we use the Fibonacci Retracements over the absolute numbers of the sequence. Fibonacci Retracement is simply a relationship between two different numbers in the Fibonacci sequence – dividing one number in the sequence from another. The ratios thus obtained and used for the trading purpose are 23.6%, 38.2%, 50%, 61.8%, and 100%. Also, Fibonacci extensions, levels beyond the standard 100% ratio (commonly used extension levels in trading – 161.8%, 261.8%, and 423.8%) are used to forecast support and resistance levels. Please note that the support and resistance levels forecasted are always an approximation and not absolutely accurate. However, it is observed that the forecast made through Fibonacci Retracements is more highly accurate compared to other methods.

#### Use of Fibonacci Retracements for profitably trading in the stock market

Every stock, while moving in a certain direction, will retrace (move in the opposite direction) a bit at intervals. Fibonacci Ratios are used by traders to identify the extent of these retracements in order to take positions. It can be used for both, up-trending and down-trending stocks. It also helps in understanding when a retracement may be indicating a trend reversal.

While trading, traders identify the 100% move both in the upside and the downside. To pick these two points, select the most recent peak (highest price level) and the most recent trough (lowest price level). Then, either use, a Fibonacci tool if available or, calculate the ratios manually (23.6%, 38.2%, 50%, 61.8%) and mark those points on the chart. Please note, you can use Fibonacci Retracement for both an up-trending stock and a down-trending stock. After doing this, your chart would look somewhat like:

In the above chart, Nifty50 is moving upwards. Hence, I have constructed a Fibonacci Retracement with the most recent trough as 100% and the most recent peak, 0%. Do not get confused here. The percentages (0%, 100%, 50%, etc.) represent the Retracement ratio (up to which a stock may move in the opposite direction of the prevailing trend) and not the trend movement.

In the above scenario, following possibilities are considered by traders for taking positions:

**Halfway back**– Usually, it is anticipated that the price retraces maximum to 50% Retracement level on the Fibonacci Drawing in the chart before resuming the trend movement whether upward or downward.**Failure Level**– When the price in Retracement moves beyond the 61.8% mark, it is anticipated that the current trend may not resume and hence, there is a sideway trend coming in or a trend reversal.**The target**– However, when the price moves to -23.1% (above the 0% mark in up trending chart and below the 0% mark in down trending chart), the traders book their profits and enter into fresh trades with fresh calculations thereon. The next series may start from the current Halfway back levels.**When Extensions Fail, Trends Fail**–

#### Concluding Remarks

Fibonacci Retracement has a greater depth to it than demonstrated here. However, for a starter, it is important to practice and get used to the calculations of the sequence. The most interesting benefit of using the Fibonacci Retracement method is that it helps to book profits even when you have taken the wrong trade. For example, you bought a stock at a 100% level expecting the price to rise. However, you did not book a profit of 23.6% or 0%. The price retraced beyond 61.8%. In this case, you still have a chance to book your profit at 61.8% – 78.6% level through your profit may be minuscule or nil. It saves your capital. Once you are accustomed to using Fibonacci in the manner prescribed above, it is beneficial to understand the depth of its use for more accurate forecasts and trades.