A Fibonacci retracement is a popular tool that is used in technical analysis that is commonly employed by a number of traders. This method is used to track possible support and resistance levels of any given asset. Fibonacci’s sequence of numbers is not illustrated using mathematical relationships, like ratios. Instead, each level is associated with a percentage. The percentage is how much of a prior move the price has been retracted. The most common Fibonacci retracement levels are 23.6%, 38.2%, 61.8% and 78.6%. Fibonacci ratio 61.8% is also called the golden ratio. It is calculated by dividing 34 by 55 (34/55= 61.8%). This numerical relationship underlies retracement studies. The indicator is used as it can be drawn between any two significant price points, usually a high and a low point. Then the indicator creates the levels between those two points. These levels are used as technical indicators before taking any decisions.
Even when the trader is using Fibonacci retracements, yet it is quintessential that each trader must add other indicators to his/her analysis. It is so because Fibonacci Retracements rely on abstract and universally applicable mathematical formulas and very less on the little data which is the actual underlying asset. These must be incorporated into these models.
Fibonacci retracements are not only used to identify support and resistance lines and trade breakouts but also used for stop-loss placements and countertrend target pricing. They are best complemented with other breakout indicators such as momentum oscillators and volatility tools.
The commonly used technical indicators are:
- Bollinger Bands
This is the most commonly used technical indicator among Fibonacci traders because of their ability to confirm breakouts based on an asset’s current trading range. Congestion from a Fibonacci retracement can be seen as quite helpful in predicting especially when the upper and lower Bollinger Bands have been contracting at the same time, confirming the likelihood of a breakout.
- Moving Average Convergence Divergence (MACD)
This is another technical indicator that is a good fit with Fibonacci analysis. The MACD shows the relationship between two different moving averages. Traders use these two moving averages to spot crossovers, divergences and/or trends with significant momentum. All those traders who have a preferred stochastic oscillator for trend confirmation can employ those instead of the MACD.
The Fibonacci retracement strategy can play a support role in many different breakout trading systems. It can help in identifying natural exits or stop loss placements. These signals can be quite stronger if the asset has some natural Fibonacci clusters around certain support or resistance lines.
Traders can also use simple volume measurements, such as advancing and declining stocks, with major indexes or exchanges. These can help the trader to differentiate between a normal post-movement retracement and also a possible reversal.
Both of these indicators help in using Fibonacci Retracement to the best of its abilities. It is based on abstract ideas and not typical calculations. Therefore it is not completely reliable and definitely the only indicator to rely on. It is always good to analysis more before investing your money.
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