Wednesday , 22 May 2024

Fibonacci Retracements: What Are They? How Do They Work?

Today, I’ll be discussing Fibonacci retracements…a technical indicators…[that]investing3 can help predict when, and to what extent, both pullbacks and rallies could occur.

The original article has been edited here for length (…) and clarity ([ ]) by – A Site For Sore Eyes & Inquisitive Minds – to provide a fast & easy read.

What exactly are Fibonacci retracements?

They’re ratios that indicate when price reversals may be drawing near. What this means is that when a price line hits these levels, it signals a possible turnaround. When other technical indicators also point to a turnaround at the same time, the signal is amplified.

The most common Fibonacci ratios are 23.6%, 38.2% and 61.8%. (You’ll also see a 50% level with most Fibonacci charts – though technically, it’s not a part of the Fibonacci sequence.)

Where these ratios come from

Well, we have to go back nearly a thousand years to identify their origins.

Leonardo Pisano Bigollo (aka Fibonacci) was a mathematician from Pisa who introduced the Fibonacci sequence to the West in the 12th century. It is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 and so on to infinity.

Fibonacci demonstrated how a number divided by the previous number in his sequence approximates 1.618 and, lo and behold, a number divided by the next highest number approximates 0.6180. It’s known as the “golden ratio,” and it is the ratio I consider the most important. (By the way, the inverse of 1.618 is approximately 0.618!)…

The next most significant number? It’s 0.3820. It’s the number you get when you take one of Fibonacci’s sequence numbers and divide it by another one two places higher. For example: 13/34 = .382. (Also note that 1 – .618 = .382.)…

To illustrate just how Fibonacci works, I’m going to show you three bitcoin charts. For purposes of clarity, I’m not including other technical indicators, so keep in mind these charts have been simplified to an extent.

After a long climb, bitcoin finally peaked last December and began retracing some of the gains it previously made. Remember, I said that 61.8% was the level I paid most attention to. You’ll notice in the chart that once prices broke below that important level, they immediately began a new leg up.

What can you do with this information?

When others may be thinking of selling, you’re thinking of buying on the dip. At the very least, it prevents you from selling at the wrong time.

Here’s another bitcoin chart using the Fibonacci levels from earlier, identifying a smaller leg up from last September.

As prices approach the 61.8% level, the possibility of a price reversal once again presents itself and another buying opportunity is indicated in advance using the Fibonacci levels.

What can the Fibonacci levels tell us about current price movements?

With prices just shy of the 61.8% level, they say that a rally could be imminent.

A couple of things to remember here:

  • While Fibonacci puts me on the alert for a price reversal, I like to see it actually happening before issuing a buy or sell alert
  • and, as I’ve said, I like to see other indicators supporting what Fibonacci is telling me.

As I mentioned last week, we’re dealing in probabilities here, not certainties. Even though I now have a technical system in place (I call it the “Cadillac of technical analysis systems”) that tells me how much lower prices need to go for an upswing to occur, there are no guarantees. Nonetheless, these kinds of technical analysis tools go a long way in helping me understand  price trends and manage risk.

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