Fibonacci Retracement Levels are becoming extremely popular with investors and traders. Because of both their simplicity and consistency, Fibonacci Retracement Levels are on of the many tools that we use here at Option Alpha for our daily market analysis. But how can YOU use Fibonacci Retracement Levels in your own daily trading? First, let’s get a quick history lesson.
Who Was Leonardo Fibonacci?
Fibonacci Retracement levels are calculated based on the Fibonacci Sequence. And this sequence and its implications was discovered by Leonardo Fibonacci. No prizes for guessing why it’s called Fibonacci Retracements right!
This indicator uses the mathematical ratios discovered by Leonardo Fibonacci based on the constant relationship between a sequence of numbers. This sequence of numbers is called the Fibonacci Summation Series.
1, 1, 2, 3, 5, 8, 13….
When adding two consecutive numbers, you will get the next…
1 + 1 = 2,
1 + 2 = 3,
2 + 3 = 5,
5 + 3 = 8, and so on to infinity.
What’s interesting about these numbers is the constant relationship between them.
- The sum of any two consecutive numbers equals the next higher number
- The ratio between any number and the next higher number approaches 0.618 after the first four calculations
- The ratio between any number and the next lower number is approximately 1.618 (the inverse of 0.618)
These relationships create the familiar Retracement Levels we have come to recognize in stock charting.
How To Use Fibonacci Retracement Levels In Trading?
The most common use of the Fibonacci’s are the Retracement Levels which are again based on the 0.618 levels etc. However, it is important to note here that there are other Fibonacci tools: price extensions, fans, etc. But for our purposes, we will focus on the Retracement Levels.
The easiest and most effective way to use Fibonacci’s is as “general” support and resistance targets. I use the word “general” here specifically because that’s all they are, targets for possible market turns. If you use them in addition to other reliable trading indicators and tools, your chances of success only increase.
Here’s a recent chart of the $RUT (Russell 2000 Index). As you can see the $RUT has hit it’s blue Fibonacci Levels multiple times before in the past. As such, we can assume the most recent level will act as support going forward and it would be profitable to enter a long trade here.
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