Fibonacci Retracement Levels
Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur. They are based on Fibonacci numbers. Each level is associated with a percentage. The percentage is how much of a prior move the price has retraced.
The indicator is useful because it can be drawn between any two significant price points, such as a high and a low. The indicator will then create the levels between those two points.
The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used.
For example, suppose the price of a stock rises $10 and then drops $2.36. In that case, it has retraced 23.6%, which is a Fibonacci number. Fibonacci numbers are found throughout nature. Therefore, many traders believe that these numbers also have relevance in financial markets.
The Formula for a Fibonacci Retracement Level
Fibonacci retracement levels do not have formulas. When these indicators are applied to a chart, the user chooses two points. Once those two points are chosen, the lines are drawn at percentages of that move.
Suppose the price rises from $10 to $15, and these two price levels are the points used to draw the retracement indicator. Then, the 23.6% level will be at $13.82 ($15 – ($5 x 0.236) = $13.82). The 50% level will be at $12.50 ($15 – ($5 x 0.5) = $12.50)
Key features of Fibonacci retracement levels
- Fibonacci retracement levels connect any two points that the trader views as relevant, typically a high point and a low point.
- The percentage levels provided are areas where the price could stall or reverse.
- The most commonly used ratios include 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
- These levels should not be relied on exclusively, so it is dangerous to assume the price will reverse after hitting a specific Fibonacci level.
Fibonacci extensions are a tool that traders can use to establish profit targets or estimate how far a price may travel after a retracement/pullback is finished. Extension levels are also possible areas where the price may reverse.
Extensions are drawn on a chart, marking price levels of possible importance. These levels are based on Fibonacci ratios (as percentages) and the size of the price move the indicator is being applied to.
The Formula for a Fibonacci Extension Levels
Fibonacci extensions don’t have a formula. When the indicator is applied to a chart the trader chooses three points. Once the three points are chosen, the lines are drawn at percentages of that move. The first point chosen is the start of a move, the second point is the end of a move, and the third point is the end of the retracement against that move. The extensions then help project where the price could go next.
Key features of Fibonacci extension levels
- Common Fibonacci extension levels are 61.8%, 100%, 161.8%, 200%, and 261.8%.
- The Fibonacci extensions show how far the next price wave could move following a pullback.
- Fibonacci ratios are common in everyday life, seen in galaxy formations, architecture, as well as how some plants grow. Therefore, some traders believe these common ratios may also have significance in the financial markets.
- Extension levels signal possible areas of importance, but should not be relied on exclusively.
The Difference Between Fibonacci Extensions and Fibonacci Retracements
While extensions show where the price will go following a retracement, Fibonacci retracement levels indicate how deep a retracement could be. In other words, Fibonacci retracements measure the pullbacks within a trend, while Fibonacci extensions measure the impulse waves in the direction of the trend.