Technical Trading Tuesday: Fibonacci Retracements
Welcome to Technical Tuesdays, where each Tuesday we'll publish a blog post about a different method of technical analysis. Just because we publish something doesn't mean we use it, but an informed trader is a successful trader so the general knowledge can be helpful. Today's topic: Fibonacci Retracements.
Fibonacci retracements are a technical analysis tool used to identify potential levels of support and resistance in financial markets. They are based on the mathematical principles of the Fibonacci sequence, which is a series of numbers where each number is the sum of the two preceding numbers. The sequence starts with 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and so on.
The Fibonacci sequence has many interesting properties, including the fact that the ratio of any two adjacent numbers approaches the golden ratio of 1.618. This ratio is found in many natural phenomena, such as the arrangement of leaves on a stem or the spiral pattern of a seashell.
In financial markets, Fibonacci retracements are drawn by identifying a high and low point on a chart and then dividing the vertical distance between them by key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. These ratios correspond to horizontal lines on the chart, which can be used as potential levels of support and resistance.
To use Fibonacci retracements, traders first identify a trend in the market, either up or down. They then draw the retracement levels from the high point to the low point of the trend. If the market is trending up, the retracement levels are drawn from the low point to the high point.
Traders use Fibonacci retracements in a few different ways. One common approach is to look for price to bounce off of a retracement level and continue in the direction of the trend. For example, if the market is trending up and the price retraces to the 38.2% level, traders may look for the price to bounce off of this level and continue higher.
Another approach is to look for multiple Fibonacci retracement levels to converge at a single price point. This is known as a Fibonacci cluster and can provide a stronger level of support or resistance.
It's important to note that Fibonacci retracements are not a foolproof method for predicting market movements. Like any technical analysis tool, they should be used in conjunction with other indicators and analysis methods to make trading decisions.
In conclusion, Fibonacci retracements are a popular technical analysis tool used to identify potential levels of support and resistance in financial markets. They are based on the mathematical principles of the Fibonacci sequence and can be used in a variety of ways to inform trading decisions. However, traders should use caution and not rely solely on Fibonacci retracements when making trading decisions.
To add this metric to your charts in ThinkorSwim, you can select drawings > drawing tools > fibonacci retracements.