Why do traders use Fibonacci retracements?
Markets rarely move in a straight line, and often experience temporary dips – known as pullbacks or retracements. Fibonacci retracements are used by traders to identify the degree to which a market will move against its current trend.
The retracements are based on the mathematical principle of the golden ratio. The sequence for the golden ratio is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on, where each number is roughly 1.618 times greater than the preceding number.
To calculate Fibonacci retracement levels, technical analysts
draw six lines on an asset’s price chart. The first three are drawn at the highest point (100%), the lowest point (0%) and the average (50%). The remaining three lines are drawn at 61.8%, 38.2% and 23.6%, which are significant percentages in the Fibonacci sequence.
According to the golden ratio, these lines should indicate the points where levels of support and resistance are met.