Fibonacci retracement levels are based on the primary numbers identified by Leonardo Fibonacci. While the Fibonacci sequence of numbers is not as necessary, the relationship between the numbers, expressed as ratios, is what forex traders use for technical analysis while trading.
Fibonacci retracements are formed by taking extreme points, i.e., a peak and a trough, on a stock chart and dividing the key Fibonacci ratios that Leonardo Fibonacci identified as the key financial ratios. The determined levels 23.6%, 38.2%, 50 %, 61.8%, and 100% are drawn to enable traders to find out the support and resistant levels.
Although the 50% level is not a Fibonacci ratio, traders often use it due to asset prices’ tendency to continue in a particular direction after the 50% retracement.
Predicting Stock Prices with Fibonacci Retracement
Like in nature, Fibonacci retracement plays an integral role in forex trade. Technical analysts use Fibonacci retracements to identify resistance and support levels, draw support lines, set target prices, and place stop-loss orders. Traders use Fibonacci retracement levels to determine how much of a previous move the price has retraced, in which case the direction of the last trend is likely to continue.
How to Apply Fibonacci Retracement in a Chart?
A trader can use the Fibonacci retracement level to indicate an entry point to trade. For example, if the trader notices that a stock has declined at 38.2%after a significant momentum, the trader could decide to enter the trade as the asset begins to register an upward trend.
When a stock reaches a Fibonacci level, it is often deemed a good time to buy because it is speculated that the stock price will retrace, enabling the trader to recover losses.
The Disadvantages of Using Fibonacci Retracement
There are a few conceptual and technical cons of using Fibonacci retracements,
Firstly, traders need to know that Fibonacci retracements are highly subjective. Not all traders understand how to use Fibonacci explicitly fully. Hence those who do and make a profit verify the effectiveness of the tool.
Traders also argue that the use of Fibonacci retracement to make technical analysis is a self-fulfilling prophecy. For instance, if traders are all using Fibonacci ratios, then the assets’ price will be affected by this fact. For example, traders using Fibonacci place a stop-loss order below the 200-day-day moving average of a company.
If a large number of traders have placed similar trades using the same tool and within the specified period, the stock is pushed down and confirms the movement that traders expected. Similarly, other traders will be tempted to sell their positions after the asset price decreases, thereby reinforcing the trend’s strength.
Although the short-term selling pressure in such cases is fulfilling, it has minimal bearing on whether the technical tool is not the price driving factor in weeks or months.
Fibonacci is also a numeric anomaly that is not grounded on any logical proof. Thus, the sequences, ratios, integers, and formulas of Fibonacci retracement are a product of a mathematical process and hence make the tool unreliable. It is important to note, however, that Fibonacci retracement levels are not inherently unpredictable.
The underlying principle of any Fibonacci tool is a numerical anomaly that is not grounded in any logical proof. The ratios, integers, sequences, and formulas derived from the Fibonacci sequence are only the product of a mathematical process.
Due to its highly subjective nature, the Fibonacci retracement strategy can only point to possible reversals, corrections, and countertrend bounces. This system struggles to confirm any other indicators and doesn’t provide easily identifiable solid or weak signals.
Fibonacci retracement levels is a great trading tool for you as a forex trader. It improves your trading by enabling you to identify opportunities for you to make entries into a trade or sell your shares. A Fibonacci retracement does this by allowing you to identify patterns that repeat themselves, thereby making your odd significantly high.
Due to the few conceptual and technical disadvantages of using Fibonacci retracements, such as its high subjectivity level, and the fact that it has no logical proof, it is advisable to trade with Fibonacci alongside another technical analysis tool to enable you to confirm anticipated outcomes.