Fibonacci Retracement

If you are a trader, you may have used technical analysis to analyse price movements and identify potential trading opportunities. While reading about technical analysis, you might have heard of the term “Fibonacci retracement”. But what exactly is it and how is it used?

In this blog, we will learn about Fibonacci retracement and understand what the tool does, how it is calculated and how you can use it on a chart.

What is Fibonacci Retracement (Fib)?

Fibonacci Retracement is a technical analysis tool that helps traders identify potential support (a zone where a falling price may start attracting buyers) and resistance (a zone where a rising price may start facing selling pressure) levels during a pullback.

It is based on the Fibonacci sequence (0, 1, 1, 2, 3, 5, 8, 13, 21, and so on), where each number is the sum of the two numbers before it.  From this sequence, certain ratios emerge, and these ratios are used to draw horizontal lines in the chart.

After a stock moves in one direction, it does not move in a straight line. It retraces or pulls back before continuing on its original path (or sometimes reversing direction entirely). Fib retracement levels help traders visualise potential price zones where a pullback might pause or reverse.  It is important to remember that these price points indicate possible zones of interest, not guaranteed turning points.

What is the Fibonacci extension?

While retracement looks at pullbacks within an existing trend, Fibonacci extension is used to project how far the price might travel beyond the previous high or low, once the trend resumes.

For example, a stock price moves from ₹100 to ₹200 and then pulls back to ₹150 (that’s a retracement). The Fibonacci extension helps the trader estimate where it might go next if it starts climbing again, say ₹220 or ₹250.

Traders often use Fibonacci extension levels to set potential price targets or to get a sense of where a stock could head next, based on the size of its previous move.

Fibonacci retracement levels

Understanding these levels is a key part of any Fibonacci retracement strategy, as they help traders identify potential areas where the price may react during a pullback.

• 23.6%
• 38.2%
• 50% (not a true Fibonacci ratio, but widely used alongside the others)
• 61.8%
• 78.6%

These percentages show how much a price has been retraced. For example, if a stock rises from ₹100 to ₹200 and then begins to retrace, the 61.8% retracement level would be around ₹ 138.20 (₹200 − ₹61.80). Traders often monitor this area to see whether buying interest emerges.

Among these, 61.8% is often considered the golden ratio. Traders often keep an eye on this level, watching for signs that the price might pause, reverse, or simply carry on in the same direction.

Difference between Fibonacci retracement and Fibonacci extension

Advantages and Limitations of Fibonacci retracement in the share market

Steps to find the Fib retracement tool with Choice FinX

1. Log in to your Choice FinX account and open the chart of the stock or index you want to analyse.
2. Look for the toolbar on the left of the charting window; this usually has the drawing and indicator tools.
3. Select the Fibonacci Retracement tool from the list of drawing tools (it may be grouped under "Fibonacci" or "Technical Tools").
4. Once selected, click on the chart to start drawing.

How to draw a Fibonacci retracement on a stock chart?

Drawing a Fibonacci retracement correctly starts with identifying the right swing points:

1. Identify the trend: Look at a chart and observe if the stock is moving up (uptrend) or down (downtrend).
2. Select the Fibonacci tool: choose the Fibonacci retracement tool from your charting platform (choice Finx).
3. Move the tool:

• During an uptrend: Click on the swing low (the lowest point of the trend) and continue dragging your tool to the swing high (the highest point of the trend).
• During a downtrend: Click on the swing high and continue dragging down your tool to the swing low.

1. Observe the lines: the tool will automatically plot horizontal lines at 23.6%, 38.2%, 50%, 61.8%, and 78.6% between your start and end points.
2. Watch price action near these levels: Look for signs such as candlestick patterns, volume changes, or support/resistance reactions as price approaches each level.

Conclusion

The Fibonacci retracement is a technical analysis tool that helps identify the resistance and support levels in the chart after a significant price move. Similarly, the Fibonacci extension assists in estimating possible price targets if the trend continues. Fibonacci retracement and Fibonacci extension are based on historical price movements and probabilities. They do not guarantee future price movement.  To make informed decisions while investing, consider combining Fibonacci analysis with other technical indicators and market trends.

FAQs

Which Fib retracement level is most important for traders?

While all levels have their uses, the 61.8% level (often called the "golden ratio") is widely monitored because prices sometimes react around this level.

Can Fibonacci Retracement be used for intraday trading?

Yes, Fibonacci retracement can be used for intraday trading on shorter timeframes, such as a 5-minute timeframe or 10-minute timeframe, to identify potential entry points during a trend. But always combine this analysis with other indicators, as prices can be volatile on shorter timeframes and levels might be less reliable.

What is the Golden Level of Fibonacci retracement?

The 61.8% level is commonly referred to as the "golden ratio" or "golden level," derived from the golden ratio found in the Fibonacci number sequence.

Can Fibonacci levels help identify entry and exit points?

Fibonacci levels can help traders identify potential zones of interest for exit and entry points, especially when combined with other tools such as candlestick patterns, moving averages or trendlines. However, they should never be relied upon in isolation, as the prices may not always react at these levels.

Does Fibonacci retracement work for all stocks, or only trending ones?

Fibonacci retracement can be more effective in stocks or indices with clear trends. When stocks move sideways or are highly volatile, the levels can be less reliable, as there isn’t a strong directional move to measure.

Can Fibonacci retracement predict future stock prices?

No. Fibonacci retracement does not predict future prices. It highlights potential areas where prices may react, but market movements depend on various factors.