Fibonacci Retracement Definition Chart

Fibonacci Retracement Definition in Trading

Do you know the Fibonacci Retracement definition? We need to know where to expect support and resistance levels with technical trading. Fibonacci retracements are horizontal lines indicating where support and resistance will likely occur. The levels stem from a Fibonacci sequence, a mathematical formula that originated in the 13th century. This is also known as the Golden Ratio.

Each Fibonacci level has an associated percentage, which is related to how much the prior price movement retraced. Retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. Some will also use a 50% retracement level (though not a classic Fibonacci).

The indicator is useful because it can easily be drawn between two significant price points (e.g., a high and a low). The indicator will then automatically draw the levels between those two points.

stock that rises $100 and drops $23.60 will have retraced 23.6%, our first Fibonacci number. This Golden Ratio is seen in nature, and many traders believe the numbers have financial market relevance. Support and resistance are so important in trading. Therefore, it’s good to know the Fibonacci retracement definition.

Fibonacci Retracement Definition

Fibonacci Retracement Levels

There’s no difficult formula to find the Fibonacci levels except to take the levels and find the percentage difference between two chosen points. In essence, that’s the Fibonacci Retracement definition. When the indicator is applied, you will choose the 2 points, and the lines will be drawn at the Fibonacci percentages of those two lines.

If a price moves from $100 to $150, and we chose these levels as our endpoints, the retracements for the 23.6% level are:

$150 – ($50 * 0.236)= $138.20

The 50% level is:

$150 – ($50 * 0.5)= $125.00

We can find the rest of the levels by substituting the retrace percentages with the last number before the equals sign.

History

So, where did these retracements come from? They’re found using the golden ratio. If you start a sequence of numbers from zero, then one, and then keep adding the prior two numbers together, you will get the following string of numbers:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987… continuing indefinitely

Our retracement levels are obtained using this string of numbers. Starting with 34, dividing any number by the number to its right will result in 0.618 (if we use 34, we mean 55), and two numbers to its right (89) is .382. 50% isn’t on this list; it’s not a true Fibonacci. This is why it’s important to know the Fibonacci Retracement definition.

The 0.618 Golden Ratio can be found in nature (see above photo) and artificial structures (see below).

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Using Fibonacci Retracements for Trading

Fibonacci retracements have several uses; we can place entry orders, use them as stop-loss levels, and set price targets. If you see a stock moving higher and then retrading to the 61.8% level and starting to climb again, you can put in a buy order for the current price and set your stop loss at that 61.8% level. 

It is a failed rally if it falls below the Fibonacci level again. Fibonacci lines are found in other technical analyses, such as Elliott Wave Theory and Gartley patterns. These technical analyses show that reversals happen near the defined Fibonacci levels after large movements.

Because the Fibonacci levels are static (unlike a moving average), they’re easy to identify. You can then react prudently when a price level is reached/tested. The levels are an inflection point where price action will likely occur and can reverse or break.

This is hopefully helpful in learning the Fibonacci Retracement definition.

Difference Between Retracements vs. Extensions

Fibonacci retracements will use percentages to determine a pullback; however, Fibonacci extensions will apply the ratios to a move in a trending direction.  Say a stock moves from $100 to $75; this is a retracement; however, an extension is if it rallies to $161.8.

Limitations of Fibonacci Retracement

The retracements predict where there may be support and resistance, but there is no guarantee this will happen. Other confirmation signals should be incorporated into a strategy that uses Fibonacci retracements. There are also so many levels that a reversal is likely to happen eventually; therefore, it is hard to determine which retracement level will see the turn.

Final Thoughts

The Fibonacci Retracement definition isn’t hard to understand. Fibonacci retracements can be incorporated into your trading to better decide entry and exit points. The full list of points used by Fibonacci adherents is:

23.6%, 38.2%, 50% 61.8%, 78.6%, 100%, 161.8%, 261.8%, and 423.6%

These are the levels we would expect a price to stall or reverse. While these levels can help with trade decision-making, they should not be used exclusively. As always, never risk with one trade more than you are willing to lose, and good luck with all of your trades.

Frequently Asked Questions

A Fibonacci retracement shows how much the price has retraced to a prior move. It helps confirm a trend.

61.8 is considered a Golden Ratio because it's a number in the Fibonacci series divided by the number following it. 

The most popular Fibonacci retracement levels are 23.6%, 38.2%, 61.8% and 78.6%.

The Fibonacci retracement is a good indicator of the stock staying within a trend and the extent of that trend. Then you know a good price target. 

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