Trading 101: What Are Fibonacci Retracements?

Fibonacci retracements use the well-known mathematical sequence to pinpoint potential turning points in the market.

How do Fibonacci retracements work?

Fibonacci retracements are a popular technical analysis tool used to identify potential support and resistance levels. They are based on the well-known Fibonacci sequence, a mathematical series where each number is the sum of the two preceding ones (e.g., 0, 1, 1, 2, 3, 5, 8, 13, 21, and so on), and which appears frequently in nature.

Sunflower seeds, illustrating Fibonacci numbers in nature.
The number of spirals of seeds in each direction tends to be two Fibonacci numbers. (Image: Pixabay)

Using Fibonacci Retracements

In trading, Fibonacci retracements are drawn by identifying a significant price move—typically a swing high and a swing low—and then applying Fibonacci ratios to that move. The most common Fibonacci ratios used in retracements are 23.6% (or 0.236), 38.2%, 50%, 61.8%, and 78.6%. These ratios are derived from dividing a number in the Fibonacci sequence by the number that follows it. (E.g. 13/21 = 0.618, 13/34 = 0.382, 13/55 = 0.236, and so on.)

Bitcoin 3-day chart with Fibonacci lines.
Fibonacci lines often coincide with turning points.

After a significant price move, the price often retraces or pulls back, before continuing in the direction of the original trend. Fibonacci retracements help identify potential levels where such retracements might occur. The key Fibonacci retracement levels act as potential support (in an uptrend) or resistance (in a downtrend). Traders may look for buying or selling opportunities at these points.

The most commonly used Fibonacci retracement levels are the 38.2% and 61.8% levels. (The 50% level, although not a true Fibonacci ratio, is also widely used.) Traders often look for price reversals or signs of a continuation of the trend at or near near these levels. The 23.6% and 78.6% levels are considered less significant but may still be monitored by some traders.

Finding Confluence

Like any technical indicator or tool, Fibonacci retracements are not foolproof and should be used in conjunction with other tools and indicators to confirm potential trade entries or exits. In the chart above, for example, the Fibonacci retracements from the swing low at $15,479 to the swing high at $31,500 often coincide with previous support/resistance levels.

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