A Fibonacci price retracement refers to the movement of the price of a stock and in particular, its tendency to retrace earlier movement. These retracements can be mapped and using the Fibonacci ratios. Here is everything you need to know about Fibonacci price retracement.
Fibonacci Sequence
The Fibonacci sequence acts as the foundation of the whole concept of Fibonacci price retracement and subsequent analysis. The Fibonacci sequence is one of the most famous mathematical progressions and is obtained by adding the two preceding numbers to derive the third number and so on. Fibonacci sequencing is seen in many natural features including our DNA strands among other things. It is thought that the sequence works in the trading world because market prices are driven by human psychology.
How Fibonacci Retracements are Worked Out
Traders calculate the price retracement levels by calculating the vertical distance between the highest price point of the stock price with the lowest. This is then divided by Fibonacci ratios to obtain the Fibonacci price retracement levels. At the start of the retracement, you get 0% and complete reversal of earlier wave is designated as 100%.
Working Out Support and Resistance Levels
The ultimate aim of calculating Fibonacci retracement levels is to be able to determine the support and resistance levels of a stock price. For example, the support level refers to the lowest point that a stock price will go before it is reversed by market forces. The resistance level, on the other hand, is the highest it will go before market forces exert downward pressure. Understanding support and resistance levels help traders to know when they should sell and when they should hold on to a stock.
How Fibonacci Price Retracements are Used
Sometimes the use of Fibonacci Price retracement becomes a self-fulfilling prophesy that drives the market. For example, if traders in a given region think (from their calculations) that a retracement is about to happen, they may respond by placing pending orders at the price their calculations show. If enough traders do this, they may end up driving the market in precisely the same direction as their calculations had indicated.
Common Mistakes
Traders who use the Fibonacci retracement approach to calculate when to enter and exit markets often make these mistakes when using this approach. They may rely on this approach too much when analyzing short term trends. Fibonacci retracement levels work better when analyzing long term trends rather than short term trends. The second common mistake is to mix the Fibonacci levels when calculating support and resistance levels. Traders also often make the mistake of relying solely on data from this approach when making market decisions. Experts recommend using different methods and then making a decision based on the trends shown by the various results.
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