Fibonacci ratios are used as a guide for determining support and resistance levels for financial assets, such as stocks and commodities.
Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci Numerical Sequence named after Leonardo Fibonacci, a 12th Century Italian mathematician from Pisa.
The Fibonacci sequence is an additive numerical sequence named after Leonardo Fibonacci of Pisa, an Italian mathematician of the late twelfth century. Leonardo analyzed a number of repeatable number formations found within nature to form the Fibonacci number sequence. Fibonacci numbers are formed by adding together the preceding two numbers in a sequence to find the next. For example 1+1=2, 2+1=3, 3+2=5, 5+3=8 etc.
Technical analysts generally utilize five Fibonacci Ratios: 0.236, 0.382, 0.500, 0.618 and 0.764. These ratios are derived from a significant low to a high of a market move. Following a significant move the assets price will often find natural support at the levels that directly correspond to the price increase multiplied by each Fibonacci Ratio. Since there are five Fibonacci Ratios, there are also five Fibonacci levels.
Fibonacci is most commonly applied in one of two ways.
Retracement Levels The ratios are applied to the high and low of a recent move (0-100%) to identify levels where the market is likely to 'retrace' or pullback to as the current trend stalls. These temporary setbacks are used by traders to position in readiness for the resumption of the preceding trend.
Extension Levels In this instance Fibonacci is used to project the likely extension of a move. An extension is any price move beyond 100%. Popular extension levels are 161.8%, 261.8% and 423.6%. These levels are used by traders as predictive areas where profits may be booked following strong preceding move.